What does that really mean?
When you invest your money, there is typically a chance that you will earn money, but also some chance that you will lose money. Some investments have the potential to earn you a lot, but typically, these investments also have the potential to lose you a lot. Other investments don't have quite as much earning potential, but your chance of losing money on these investments is also quite low. This second kind of investment—the type that probably won't result in you losing money—is commonly called a low-risk investment.
A Closer Look
To better understand what low-risk investments are, you must first understand the meaning of the word "investment." Strictly speaking, an investment is any asset you purchase today with the hope that it will increase in value in the future. That asset can be almost anything. If you buy a gold coin with the hope of selling it for more in two years, that's an investment. If you park your money in a savings account with the intent of it earning interest, that's an investment.
So if you consider an investment something you buy with the hope it will increase in value, you have to acknowledge there is a chance it won't increase in value, but will actually decrease in value. With some investments, that chance is high. With other investments, that chance is low. If the chance of losing money is low, the investment is low risk.
Here's the downside of low-risk investments, though. Even when they do earn you money, they tend to earn less than a riskier investment. Less risk equals less reward.
When Low-Risk Investments Work Well
So, if you can be pretty sure you will not earn as much on a low-risk investment as on a high-risk investment, why would you make that investment in the first place? Because the money you earn is almost a sure thing. Look at it this way. You could buy an investment that you're 98% sure will earn you 2.00% interest, or you could buy an investment you're 50% sure would earn you 8.00% interest. If you can't stand to lose any money, a low-risk investment is the better choice in your situation.
Low-risk investments are a good idea when you're investing money you will need to withdraw in a couple of years. For instance, if you are investing money specifically to buy a car in two years, you are better off investing in a low-risk, 2.00% fund than betting on a high-risk, 8.00% fund and risking the loss of money you really need for that car.
Low-risk investments are also useful for balancing out other higher-risk investments in a total portfolio. For instance, if you are saving for retirement, it is good to balance out your high-risk stock investments with some low-risk bonds to ensure that if the high-risk investments do tank, you don't lose everything.
Common Low-Risk Investments
A savings account is an example of a very low-risk investment. There's almost zero chance of you losing the money, but it will only earn 1.00% interest, at most.
Bond funds and bonds are also low risk. Many earn 2.00% or 3.00% with little risk of loss.
Certificates of deposit (CDs) are a very low-risk investment as long as you invest through an FDIC-insured bank. Basically, you deposit your funds into a bank account and agree not to remove them for a certain period, often two or five years, in exchange for a set interest rate, which is often around 2.00%.
When you can't afford to lose money, but you do want that money to be earning something, low-risk investments are the best option. Look to bonds, savings accounts, and CDs for the earnings and safety you need. For more information on low-risk and other types of investment options, speak with a financial advisor.
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