One of the common mistakes made by many investors suggests that this investment is either “safe” or “risky”. But the multitude of investment offers available today cannot be classified as easy.
There are several types and levels of risk that these investments may have:
- Market risk: the risk that an investment may lose its value in the market (refers primarily to stocks and, secondly, to investments with a fixed income)
- Interest rate risk: the risk that an investment will lose value due to a change in interest rates (applies to fixed income investments)
- Reinvestment risk: the risk that investments will be reinvested at a lower interest rate when it is matured (applies to investments with a fixed income)
- Political risk: the risk that foreign investment will lose value due to political actions in this country (stocks located in developing countries are particularly susceptible to this)
- Legislative risk: the risk that investments will lose value or other benefits that they offer due to new legislation (all investments are subject to this risk)
- Liquidity risk: the risk that investments will not be available for liquidation when it is required (applies to fixed income investments and real estate and other property that cannot be quickly sold at a fair price)
- Potential purchase risk: the risk that an investment will lose its purchasing power due to inflation (applies to fixed income investments)
- Tax risk: the risk that an investment will lose its value or return capital due to taxation (most investments are subject to this risk)
Fixed income investments, such as bonds, usually fall under interest rate, reinvestment, purchasing power and liquidity risk, while stocks and other investments are more vulnerable to market risk. And while some investments, such as municipal bonds and annuities, are at least protected from tax risk, investments are not protected from political or legislative risk.
Of course, the specific types of risks that are relevant to an investment will vary depending on its specific characteristics. The level of risk that a certain stock carries will also vary depending on its type, since a small portfolio in the technology sector will obviously have much more market risk than preferred stock offer.
In general, the level of risk that an investment deposit bears directly depends on its potential rewards. With this in mind, the investment risk spectrum for remuneration can be broken down as follows:
- Safe: Savings Bonds, Life Insurance
- Very low risk: fixed and indexed annuities, insured municipal bonds
- Low risk: investment grade corporate bonds (rated BBB or higher), uninsured municipal bonds
- Moderate Risk: Preferred Shares, Mutual Funds Revenues
- Medium risk: mutual fund stocks, blue chip stocks, residential real estate
- High risk: small and medium-sized capital stocks, mutual funds that invest in certain sectors of the economy, such as technology and energy
- Speculative: investments in oil and gas, limited partnerships, derivative financial instruments
Understanding where different types of investments fall into the risk spectrum of reward can help investors identify opportunities for greater returns while maintaining a moderate degree of security. Moreover, being aware of the specific type of risk to which investments are exposed, investors can make better decisions about what is appropriate for their situation and investment portfolio.
Risk to avoid will not succeed
There is no such thing as a risk-free investment, all investments, including those that are guaranteed to return the bulk, bear some kind of risk. But those who are ready to go into the low and medium risk investment category can find much better management of their funds and make a profit.
In these categories there are many good options for investing:
1. Preferred shares
Preferred shares are a hybrid security system that is traded as a stock but is in many ways similar to a bond. She has a declared dividend rate, which is usually about 2% higher than ordinary shares and usually trades within a few dollars of the price at which it was issued (usually $ 25 per share).
Some of the other characteristics of preferred stock include:
- Earnings from preferred shares are usually paid monthly or quarterly, and in some cases their dividends may qualify for a return on capital gains.
- Preferred shares also have very little liquidity risk, since they can be sold at any time without penalty.
- The main types of risk that preferred shares have are market risk and tax risk.
There are several types of preferred shares:
- Accrues any dividends that the issuing company cannot pay due to financial problems. When a company can catch up with its obligations, all overdue dividends will be paid to shareholders.
- Allows shareholders to receive larger dividends if the company has good financial results.
- Can be converted to a certain number of ordinary shares.
Most preferred stocks are also rated by credit rating agencies such as Moody’s and Standard & Poor’s, and their default risk is assessed as for bonds. If a preferred offer issuer is financially stable, it will receive a higher rating, such as AA or A +.
Lower ratings will pay a higher rate in exchange for a higher risk of default. Preferred shareholders can also expect to return their money from the issuer, if the company is liquidated, but they do not have the right to vote on the board of directors.
2. Shares of minerals
Like preferred shares, mineral shares, as a rule, remain relatively stable in price and pay dividends of between 2% and 3%. Other main characteristics of stocks of mineral services include:
- Mineral shares are common shares and have voting rights.
- Their prices are usually not as stable as preferred shares.
- These are non-cyclical stocks, which means that their prices do not rise or fall with economic expansion and contraction, as in some sectors, such as technology or entertainment.
- Since people and businesses always need gas, water and electricity, regardless of economic conditions, mineral stocks are one of the most protective sectors of the economy.
- Mineral shares are often rated by rating agencies as well as bonds and preferred shares.
- Mineral shares usually have a higher market risk than preferred shares and are also subject to taxation.
3. Fixed annuities
Fixed annuities are designed for conservative “retirees” who seek higher returns with capital preservation. These tools have several unique features, including:
- In exchange for their relative security, fixed annuities also pay a lower rate than mineral shares or preferred shares. Their rates typically range from 0.5% to 1%. However, some fixed annuities will also offer a higher initial rate as a means of attracting investors.
- There are also indexed annuities that can give investors a portion of the profits in the debt or equity market, guaranteeing the principal amount. These contracts can provide excellent return on capital if the markets work well.
- The main risks associated with annuities are liquidity risk, interest rate risk and purchasing power risk.
4. Brokerage certificates of deposit
This type of certificate of deposit may be an attractive option for ultraconservative investors who cannot afford to lose a single cent. These certificates have the following functions:
- Although they do not pay such high rates as preferred shares or mineral shares, certificates of deposit can pay significantly more than an ordinary interest-bearing bank deposit.
- Certificates of deposit are issued as bonds and are traded on the secondary market.
- Many brokerage firms sell this type of certificates of deposit. For example, Edward Jones used brokerage certificates of deposit to attract customers from banks that were looking for higher returns.
- Brokerage certificates of deposit bear the risk of liquidity, which is inherent in any type of bonds and is subject to taxation.
5. Mutual funds
Investors seeking higher returns would be wise to consider many of the mutual funds or other mutual funds that are now available to almost everyone who has money. These investment funds have different advantages and disadvantages from the individual offers listed above:
1) Mutual funds invest in a wide range of financial instruments related to income, such as bonds, mortgages, loans and preferred stock.
2) The diversification and professional management that they offer reduces the market and reinvestment risks found in certain securities. A combination of different classes of securities, such as bonds and preference shares, can also be profitable, and provide higher payouts with less risk.
3) Investors have a wide choice when it comes to mutual funds. There are hundreds, if not thousands, of cash available today for everything, investors should know exactly what they are looking for and analyze everything carefully before investing in these assets. Some funds are very conservative, investing only in such things as cash instruments and treasury securities, while others are much more aggressive and look at bonds and mortgage securities to ensure a high level of income.
4) In most cases, mutual funds offer their clients investments with minimal market risk, reinvestment risk and tax risk. They may also be slightly more protected from political risk and the risk of loss of purchasing power.
Investors who are looking for income have several options to choose from that can offer higher payouts with minimal risk. It is important to understand that there is no such thing as a truly risk-free investment, but different investments carry different types of risk.