If preserving your principal is important to you, you have an abundance of options to consider from bonds and bond mutual funds.While low riskalso equates to low return, many people—such as retirees and those who need to access their savings for a specific short-term need—are more than willing to give up some yield to be able to sleep at night.
With that in mind, here are eight of the leading options in the low-risk segment of the fixed income market.
Key Takeaways
- If you want to protect your principal with a safe investment, then bonds are a good option.
- Some of the safest bonds include savings bonds, Treasury bills, banking instruments, and U.S. Treasury notes.
- Other safe bonds include stable value funds, money market funds, short-term bond funds, and other high-rated bonds.
- Diversifying among two or more market segments is preferred; it helps you avoid putting all of your eggs in one basket.
1. Savings Bonds
These are thesafest investment since they’re backed by the government and guaranteed not to lose principal. They don’t offer exceptional yields, but that isn’t the point. If you want to keep your money safe, savings bonds are the best option. They’re easy to buy through TreasuryDirect, and they're tax-free on both the state and local levels. They may also be tax-free on the federal level if used to pay for education. The one drawback is that they aren’t as liquid as some other types of investments. You can’t cash them in within the first year of their life; if you have to cash them in within the first five years, you will pay a three-month interest penalty.
2. Treasury Bills
Treasury bills (T-bills) areshort-term bondsthat mature within one year or less from their time of issuance. T-bills are sold with maturities of four, eight, 13, 26, or 52 weeks. Because the maturities are so short, they often offer lower yields than those available on Treasury notes or bonds. Theirshort maturitiesalso mean that they have no risk. Investors don’t have to worry about the U.S. government defaulting in the next year, and the interval is so short that changes in prevailing interest rates don’t come into play. T-bills are also easily bought and sold via TreasuryDirect.
3. Banking Instruments
Banking instruments, like certificates of deposit andsavings accounts,are among the safest options you will find in the fixed income market, but they come with two caveats. First, be sure the institution where you hold your money is FDIC-insured. Second, make sure your total account is below the FDIC insurance maximum of $250,000. Neither of these investments will make you rich, but they will give you the peace of mind that comes with knowing that your cash will be there when you need it.
4. U.S. Treasury Notes and Bonds
Despite any fiscal problems of the U.S. government, longer-term Treasury securities are still entirely safeifthey are held until maturity. Before maturity, their prices can fluctuate substantially. As a result, if you prioritize safety, be sure that you won’t need to cash in your holdings before their maturity dates. Also, keep in mind that amutual fundorexchange-traded fund(ETF) that invests in Treasurys does not mature. That means there is the risk of principal loss.
5. Stable Value Funds
Stable value funds are an investment option in retirement plan programs such as401(k)sand certain other tax-deferred vehicles, They offer guaranteed return of principal with higher returns than typically available in money market funds. Stable value funds are insurance products; a bank or insurance company guarantees the return of principal and interest. The funds invest in high-quality fixed-income securities. Maturities average about three years, and this is how they can generate their higher yield.
Thebenefits of stable value fundsare principal preservation, liquidity, stability, and steady growth in principal and returned interest. Returns are similar to intermediate-term bond funds but with the liquidity andcertainty of money market funds. Keep in mind, though, that this option is limited totax-deferred accounts.
6. Money Market Funds
While not government-insured, money market funds are regulated by theSecurities and Exchange Commission(SEC).Money market fundsinvest in short-term securities, such asTreasury billsor short-term commercial paper. These are liquid enough that managers can meet the need for shareholder redemptions with little difficulty. Money market funds seek to maintain a $1 share price, but they could fail to meet this goal. This event is known as “breaking the buck.” This is very rare, so money market funds are seen as one of the safest investments. At the same time, they are often among the lowest-yielding options.
7. Short-Term Bond Funds
Short-term bond fundsmost often invest in bonds that mature in one to three years. The limited amount of time until maturity meansthat interest rate risk is low compared to intermediate- andlong-term bond funds. Still, even the mostconservative short-term bondsfunds will still have a small degree of share price fluctuation.
Note
Interest rate risk is the risk that rising interest rates will cause the value of the fund’s principal value to decline.
8. High-Rated Bonds
Many debt securitiescarry credit ratings. These allow investors to figure out the strength of the issuer’s financial condition.Bonds with the highest credit ratingsare very unlikely todefault, so that is rarely an issue for them and the funds that invest in them, but as with Treasury notes, even high-rated bonds are at risk of short-term principal loss if interest rates rise. This isn’t an issue if you plan to hold anindividual bonduntil maturity, but if you sell a bond before its maturity date—or if you own a mutual fund or ETF that focuses on higher-rated bonds—you are still taking on the risk of principal loss. It doesn't matter how highly rated the investments are.
The Bottom Line
Naturally, investors don’t need to choose just one of these categories. Diversifying among two or more market segments is preferred since you avoid putting all of your eggs in one basket. The most important thing to keep in mind is that under no circ*mstance should you try to earn extra yield by putting money into investments that have more risk than is appropriate for your objectives.
Frequently Asked Questions (FAQs)
Are bonds low-risk?
Bonds are typically regarded as lower-risk investments than stocks. However, all bonds (and all investments) carry some level of risk. The primary risks of bonds include credit risk (the issuer could miss interest or principal payments) and interest rate risk (interest rates could go up and suppress the prices of bonds you already own).
How safe are municipal bonds?
The safety of a municipal bond depends on the issuer and the type of bond. For example, general obligation bonds are typically issued by government entities. That makes them relatively safe, since they're backed by that government's ability to tax citizens. On the other hand, revenue bonds may be issued on behalf of colleges, hospitals, or similar entities that may carry relatively more risk.
