All investing involves some level of risk. In exchange for that risk, investments offer you the potential for a reward. Generally speaking, the higher the risk an investment carries, the higher the potential return you may earn, if things move in your favor. But there are different meanings of “risk” and “safety” when it comes to investments. For example, you can keep your life savings with a large, traditional bank and it will be insured against loss for up to $250,000 by the FDIC. But the small percentage rate of return you’ll earn there won’t come near to keeping up with inflation, meaning it will actually erode the value of your portfolio over the long run. In order to make the most of your money while keeping it pretty safe, here are some smart places to start.
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U.S. Treasuries are often one of the leading candidates for a “safe” portfolio, primarily because they are backed by the full faith and credit of the United States government. The government is continually selling new bonds to pay off those that are maturing, and in a worst-case scenario, it could even simply print more money to pay off those bonds. That might wreak havoc with the international banking system — and the U.S. economy — but the point is that there’s very little risk indeed that you won’t be made whole on your Treasury investments.
With that level of safety behind them, U.S. Treasuries typically pay a very low rate of interest. However, in recent months, the yield on Treasury securities has skyrocketed. As the Federal Reserve has aggressively raised interest rates to battle inflation, short-term Treasury rates have skyrocketed from essentially nothing to the 5%-plus range. At those levels — and with the full backing of the U.S. government — Treasuries have become quite appealing investments. As BlackRock Americas iShares Investment Strategy Head Gargi Chaudhuri recently told Yahoo Finance Live, “There is a huge amount of opportunity in the fixed-income markets, one we haven’t seen in about a decade and half.”
Most municipal bonds are just one small step above U.S. Treasuries in terms of risk. Municipal bonds are issued by state and local authorities to pay for projects that contribute to the general good, such as schools and general infrastructure. Although some municipal bonds are riskier than others, many carry not only AAA ratings — the highest quality as determined by third-party agencies — but also private insurance. In the rare case where a municipal bond was to default, in many cases, the insurance provision will kick in to make investors whole.
Municipal bonds carry an extra kicker that makes them more attractive to high-income investors. The interest paid by municipal bonds is always federally tax-free, and if you’re a resident of the same state issuing the bond, it’s also state tax-free. This can increase the effective after-tax yield of municipal bonds by a considerable amount. As interest rates have risen dramatically in the past year, municipal bonds are more attractive than ever for income investors. As George Bory, chief fixed income strategist at Allspring Global Investments said, “…a bond offers a predictable stream of cash flows, which become[s] very useful if matched up against longer-term investing horizons and spending patterns.”
Stock Market Index Funds
Stock market index funds may seem like a risky bet, but if you’ve got a long-term view, there’s hardly anywhere else better to be. On a day-to-day basis — and even from year to year — stocks can fluctuate wildly. In 2022, for example, the S&P 500 fell into a bear market, falling about 20%. But what may surprise many investors is that there has never been a rolling 20-year period in which the S&P 500 has actually lost money. That’s a remarkable track record for such a seemingly “risky” investment.
If the goal in investing is to generate long-term wealth, the S&P 500 index has been a great option. Historically, the long-term return of the index is roughly 10% per year, though year-to-year returns can vary dramatically. This means that on average, an investment in the S&P 500 index can double your money roughly every seven years. This is why no less than billionaire Warren Buffett, CEO of Berkshire Hathaway and the so-called “Oracle of Omaha,” has repeatedly stated that for the average investor, a portfolio of diversified index funds makes “the most sense practically all of the time.”
If you’re willing to take a small step up the risk ladder, investing in a portfolio of well-chosen, long-term equities is another way to fight off inflation and potentially increase your long-term returns. As with S&P 500 index funds, equities in general tend to outperform bonds and cash over the long run. If you’re buying individual equities instead of an index fund, you’ll have to be more diligent with your research and monitoring. After all, while market indexes have always recovered from bear markets to go on to new all-time highs, some individual equities never bounce back from major selloffs. But if you buy quality, dividend-paying, blue-chip stocks, your odds of a major blowup over the long run are lower than if you chase after high-flying stocks that go in and out of favor.
Strategists at J.P. Morgan Chase agree, noting that “…quality stocks…drive the long-term excess performance relative to the market.” Warren Buffett takes this idea a step further, suggesting that picking the right stocks is even more important than picking the right time to buy them. In his own words, “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
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