Is low risk right for you?
READER QUESTION: I’M LOOKING FOR THE HIGHEST RETURNS ON LOW-RISK INVESTMENTS
Igor Rodionov, managing director of Advicement Investment Services, answers:
Modern Portfolio Theory associates low risk with lower expected returns. This may not sound ideal for investors looking for quick growth but there are plenty of compelling reasons to seek a low-risk investment.
Low-risk investments make financial sense in the following cases:
Creating an emergency fund: A low-risk investment can lessen the impact of significant adverse market fluctuations.
Short-term investment horizon: A lowrisk investment can avoid a situation where you do not have enough time to recover your funds in the event of poor performance.
Avoiding investment fluctuations: If you are not comfortable when your investment fluctuates wildly, a low-risk investment is likely preferable for you.
Low-risk investment options include fixed deposits, money market, bond market and low-risk unit trusts.
Fixed deposits
A fixed deposit can be opened with any local bank. Banks guarantee and disclose upfront the return on your investment over an agreed period and early withdrawal by the investor may result in penalties. Fixed deposits are advantageous as they are not subject to outside market variables and are guaranteed by the bank. But, there is a marginal risk that the bank may go bust and won’t pay off the promised amount.
Money market
The money market asset class deals with short-term debt instruments. It can be accessed through banks, specialised unit trusts or via exchange-traded funds that track a money market benchmark.
These instruments are linked to the ability of the government and corporates to pay off their short-term debts.
Money market accounts are suitable for short-term investors as quick access to the invested amount is possible.
Bond market
Bonds are long-term debt instruments, typically issued by the government, government entities and large corporates. Bonds can be accessed through specialised unit trusts or exchange-traded funds that track a bond benchmark.
Historically, bonds have outperformed money market benchmarks, but with larger fluctuations.
A marginal risk associated with investing in bonds, is that the bond issuer may default on its payment obligation. This risk is reduced by investing in bonds issued by entities with a strong credit rating and through diversification.
Low-risk unit trusts
Unit trusts invest in instruments from the abovementioned classes. Some are low risk as they are guided by a mandate, which specifies what proportion of the portfolio can be invested in different asset classes. Returns depend on the trust selected, investment philosophy and mandate.
Before selecting a low-risk investment, it is important to consider the broader context as well as the fees involved in accessing these investments.