Investopedia/Melissa Horton: What kind of securities should a risk-averse investor buy?

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What kind of securities should a risk-averse investor buy?

By Melissa Horton | April 10, 2015 — 8:11 AM EDT
ANSWER

While most investors are focused on investment options with high rates of return, some individuals are more concerned with the level of risk inherent to specific investment allocations. Investors who are risk-averse are more apt to choose the investment that presents a lower degree of risk if given two investment options with similar expected returns. Capital preservation and income generation are common investment objectives for risk-averse investors, which leaves some high-risk investments out of the picture. However, there are a number of lower-risk investments suitable for risk-averse individuals, including traditional bank accounts, government securities, corporate and municipal bonds, and preferred stock.
Bank Products

Savings and money market accounts offer investors a stable rate of return that is guaranteed by the financial institution. Balances held within these accounts are also federally insured up to a certain limit by either the Federal Deposit Insurance Corporation, or FDIC, or the National Credit Union Administration. Similarly, certificates of deposit (CDs) offered through banks or credit unions provide investors with a stated rate of return for a set period of time and also offer insurance on the balance. Although these investment options have interest rate risk, they do not carry investment risk.
Government Securities

Risk-averse investors also have options in government securities, including Treasury Inflation-Protected Securities, or TIPS, and other government bonds. TIPS provide individuals the ability to purchase a bond with a relatively low interest rate compared to bank products but is linked directly to inflation rates. This results in an increase in the value of the bond when inflation rates rise. Other government bonds are available in a wide range of maturity dates and interest rates correlated to the length of time the bond is held. Both TIPS and other government bonds are backed by the full faith and credit of the U.S. government, eliminating market risk for these investment options.
Corporate and Municipal Bonds

Corporate and municipal bonds have greater risk of default than government securities or bank products but they are also viable options for risk-averse investors. Corporate bonds are debt instruments issued by established companies that pay a stated dividend to investors who purchase the bond. Bondholders are first in line behind creditors if a corporation defaults or becomes insolvent, making the investment safer than common stock. Similarly, a municipal bond is a debt instrument issued by municipalities such as state or local governments that pays a steady dividend to bondholders. Typically, this investment option is safer than a corporate bond issue due to the financial stability and credit of the municipality. Municipal bonds are also exempt from state and federal taxation, making their real rate of return higher than similar investment options.
Preferred Stocks

Risk-averse investors have an equity investment option in preferred stock. Companies issue preferred shares to individuals, and in return for investment, provide equity and debt ownership in the issuing company. Investors in preferred shares have the benefit of paid dividends each period and the potential to experience capital appreciation if the value of the stock increases. Dividends are paid to preferred shareholders before common stockholders, and preferred shareholders are also above common stockholders on the creditor hierarchy if a company declares bankruptcy.
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