What comes to mind when you hear the word "risk" in investing? Do you think about loss, uncertainty, or opportunity?
If you associate risk with loss and uncertainties and are very cautious when investing, you probably have a low-risk tolerance. Your risk attitude can be described as averse to neutral.
Investors with low-risk tolerance are individuals who prefer to preserve capital over chasing rewards. They will primarily invest in vehicles that guarantee the least exposure to risk, are not volatile, and are often heavily regulated. While this investment might bring them little income, it is barely enough to protect them from inflation.
So, how can you invest when you have low-risk tolerance? This article will explore some low-risk investment vehicles you can choose from and ways to invest in instruments with higher returns without exposing yourself to more risk than you are willing to endure.
You can build a portfolio consisting of low-risk investments for various reasons, including to ride out market volatility, preserve your emergency funds, avoid loss when saving for important short-term financial goals, or you simply have low-risk risk tolerance. Whatever your reason is, you will need to consider vehicles with the least risk exposure.
Some of these investment instruments are:
These are government-secured short to long-term investments that can help you generate income and preserve your cash when you have a low-risk tolerance. The CBK issues Treasury bonds and bills, and you can purchase them directly or through your bank using a CDS account.
Treasury bills have a maturity period of three months to one year and are auctioned weekly. They're sold at a discount. You pay less when purchasing them and receive their face value on maturity. These investments are great for people saving for short-term goals and who want to maintain relative liquidity.
On the other hand, Treasury bonds are medium to long-term investments with a maturity period ranging from one to 30 years. They can earn you attractive fixed interest rates that are paid semi-annually. This investment is great for individuals with low-risk tolerance investing for long-term goals like kids' education.
Treasury bonds and bills are generally safe, and you will likely not lose your money, but you are still exposed to some risks. For instance, if interest rates are raised due to high inflation, you risk making less money to keep up with your fixed interest rate bonds. The investments also expose you to liquidity risk, if you get out of your position before maturity, you will likely lose some of your initial capital.
This investment involves depositing fixed money in a financial institution like a bank or SACCO for an agreed period at predetermined interest rates. The interest rate you earn will typically be higher than prevailing market rates, and the period can range from a month to a few years. This makes it attractive for people looking to save for short to medium-term goals.
The investments are generally safe because they are either insured by the KDIC or the financial institutions are regulated by government agencies and required to prevent risking depositors' funds. Fixed deposits offer predictable returns paid on maturity, and you can borrow against your deposits.
But this doesn't mean there aren't risks involved.
The most significant risks you face are liquidity risks and time horizon risks. If you choose to withdraw your funds before maturity, you not only forfeit all interest you have accumulated but will also be penalized. This means you will withdraw less than you had deposited.
Money Market Funds or MMFs is a type of mutual fund that pools money from many investors and invests in a diversified portfolio of low-risk investments. Professionals manage the funds to ensure risks are controlled, and investors' cash is safe. MMFs promise higher returns than prevailing interest rates and can help you mitigate inflation risk.
Money Market Funds are regulated by the Capital Markets Authority, which sets guidelines meant to protect investors and ensure their funds are appropriately managed.
MMFs generally don't have maturity terms, and you can easily liquidate when you need to, this makes them attractive for investors who need to keep cash at hand while generating regular returns. Another advantage is that they offer compound interest that is compounded monthly, which means you'll be earning interest on your interest.
The biggest disadvantage MMFs have is a lack of predictability and capital risks. The returns you earn are subject to market performance. If the fund makes little return, so will you. Your capital is also at the mercy of the funds' manager. If they make investment errors and lose money, you might shoulder some of the loss and receive less than you invested.
While low-risk investments lower the chances of losing some or all your initial investments when you take risks, they have two downsides:
So how can you invest and generate higher returns when you have low-risk tolerance to ensure that you achieve your financial goals? These strategies will help you:
Asset Allocation and Diversification: This strategy involves spreading your assets in various investment vehicles, both low-risk and high-risk, depending on multiple factors like your income, expenses, risk appetite, liabilities, and time horizon.
The main reason for diversification is simple; you lower the risk of losing all your investment. If one investment doesn't perform well or brings you losses, profit from another investment will balance out the loss, and you'll break even.
Invest in Mutual Funds: Investing in high-risk instruments can be challenging when you have low-risk tolerance or lack enough financial know-how-to to prevent yourself from losing money. Mutual funds can help you overcome both those hurdles and help you realise higher returns on your investments.
Unlike money market funds which invest in low-risk vehicles, other mutual funds pool money from various investors and invest the cash in medium to high-risk instruments like stocks and securities and other dividend-paying vehicles like REITs.
A good example is equity mutual funds which invest in listed companies on Nairobi Security Exchange (NSE). Financial institutions like banks and insurance companies offer mutual funds, which means your funds will be managed by professionals working to reduce risks and losses.
Invest in Deferred Annuity: Are you worried that you might not generate enough income in retirement? Then you can start investing in pension plans that will earn you attractive monthly payments like a deferred annuity.
You can purchase a deferred annuity and start paying a premium periodically until you retire or choose to pay large-sum payments now. Once you retire, you will receive monthly income from your insurance provider, depending on your agreement. You can either receive a fixed, regular income as long as you live or for a guaranteed period, e.g., 20 years.
You can buy a single or joint-life annuity if you are married. This ensures your spouse will receive regular income after your demise.
You can buy a deferred annuity through an insurance company. You'll be paying premiums that your insurer will invest on your behalf and generate returns they share with you in your golden years, ensuring you avoid longevity risks.
Read Also: How to Plan for Retirement While in Your 30s
Buy Life Insurance: Ensuring your dependents are financially set in case of your timely demise is the best way to protect them from hardships that can drive them to poverty. One of the ways of doing that is investing in life insurance which will pay a large sum of money to your dependents after your death. They can use this to educate their children and invest in other schemes that can generate their regular income.
Hire a Financial Advisor: One of the reasons you fear taking risks is that you lack enough financial knowledge to assess risks from every angle and ensure you don't overexpose yourself more than you can endure. A licensed and reputable financial advisor can help you determine your risk tolerance, advise you on how to allocate your assets depending on your financial goals, and recommend investment vehicles that match your risk profile.
Read Also: 5 Risks to Take in Your 30s
When it comes to taking risks, there are no guarantees that you will realise positive returns. Every risk has some level of uncertainties linked to it; it's only the degree of loss you face that differs. It is therefore crucial that when taking risks, you have a risk management plan that ensures you can control, mitigate or avoid loss.
Additionally, you should control your greed level and don't exaggerate your risk tolerance and capacity. This can lead to more losses than you can bear, causing you financial stress.
When unsure about an investment, instead of writing it off or investing blindly, take your time to learn about it or ask an expert for their guidance/opinion. This doesn't just help you avoid loss but opportunity risks as well.