Investing is a wide and diverse activity, and for someone just starting out or making significant changes to an existing portfolio, it can be confusing. Finding the right investments to match your personal risk tolerance, while also giving you the liquidity you need can be challenging. Knowing which investments have the least amount of liquidity can be an important factor in deciding where your money gets parked.
The investments with the last amount of liquidity are generally going to be those with limited market demand or those that involve complex buying or selling transactions. The least liquid assets are going to be collectibles of any type, large companies or organizations, and real estate.
We're going to take a closer look at which investments have the highest degree of illiquidity, as well as what exactly makes them so highly illiquid. While liquidity and risk are somewhat decoupled, liquidity itself may pose
What Is Liquidity?
Liquidity is a term used to describe the relative ease with which a particular investment can be converted to available cash. This cash is frequently used to either reinvest or as the source of withdrawals. The higher the liquidity of the item, the easier it will be to sell or trade for cash once the investment has matured or appreciated in value. An item with low liquidity will be difficult to sell, even impossible in some cases.
This means if you are a collector of things like stamps, autographs, coins, and similar items, you may just find yourself in a bind if you need to cash out one or more of those investments. In many cases, collectibles have a very limited audience and pool of potential buyers, which means it can be incredibly difficult to sell an investment in a short time.
Which Type Of Account Has Low Liquidity?
Typically, one of the account types with the lowest liquidity is a CD account, also known as a Certificate of Deposit. For investors that have never used one, they can be thought of like a savings account that you put a specified amount of money in, that is then locked for a predetermined amount of time. Common terms for CDs are anywhere from 6 months to 1 year or more. During this time you generally cannot withdraw any of the cash in the CD, however, they often guarantee an interest rate return at maturity.
There are some exceptions, however, and some institutions will allow you to withdraw the funds prior to the maturity date of the CD with the understanding that you may pay significant penalties for the early withdrawal. These penalties can potentially be more than the amount you would have earned by leaving the funds in the CD, which means you are likely to end up with less than you started with if you cash out early. You can generally open a CD account at any local bank branch that you prefer.
Which Investment Has The Least Amount Of Risk?
Investments that have the least amount of risk will often include CDs, money market accounts, and bonds. In certain economic climates, a savings account would also be considered low risk, but with high rates of inflation and extremely low savings account interest, you are more likely to lose value as your money sits there because your return isn't enough to offset the inflationary decay. The main reason that these specific investments are considered lower risk than others is that they are largely decoupled from the general stock market, so they are affected far less than other investment instruments.
CDs are very low risk, and since they are accounts that you can open at nearly any bank you prefer, they can also be FDIC insured against loss. Money market accounts are frequently opened for you when you create an account with a brokerage, and while you may use the brokerage for buying and selling stocks and ETFs, you can also transfer in cash and simply leave it there, allowing it to gain interest commensurate with the rates the brokerage sets forth. Bonds are also an incredibly low risk since they are debt-based security and as everyone knows, debt is big business. Bonds, while being low risk, are also relatively liquid investments, being able to be sold quickly compared to other types of investments.
Best Low-Risk Investments
There are some very effective investments that you can leverage even in times of high inflation rates, and which will produce relatively significant returns. Here are some of the best ways to grow your wealth while maintaining a low personal risk tolerance.
Series I Savings Bonds
Series I savings bonds are incredibly low-risk investments that automatically adjust for inflation to help protect your initial investment. This means that as inflation becomes more significant, the return on the bonds is adjusted accordingly. The downside is that as inflation goes down, so do your returns, though the payment adjustments generally only happen twice a year. Since savings bonds are an investment security backed by the government itself, there is almost zero chance of a default
Money Market Funds
Money market funds are funds made up of pools of CDs, and other short-term and low-risk investments like bonds. They are frequently bunched together to minimize risk and volatility. You can purchase money market funds from both brokerages and firms that specialize in mutual funds. Money market funds are considered relatively liquid investments, and they will also usually allow the client to withdraw their funds at any point, without paying penalties.
ETFs, or exchange-traded funds, are one of the least risky ways to get into the stock market. Most of the risk that comes with the stock market is related to its volatility and the chance of investing in a company that will lose value. ETFs are managed funds that are traded in the same way as stocks, but the funds are composed of the most well-performing companies in that sector. The best part is, that the managers of the funds are generally able to produce much greater returns than other low-risk investment types, without requiring you to do any research legwork for the companies involved.
Certificates Of Deposit
Short-term CDs are a common way for people to invest in something low-risk while maintaining a liquidity level aligned with their short-term goals. The challenge with CDs is that the rates each one pays will be unique to the bank you open it at, so shop around before committing to one CD over another. If you suspect that you may need your funds sooner than the shortest CD term, you may also find no-penalty CDs offered, though the return will be less than conventional CDs.
Treasury Bills, Notes, & Bonds
Low-risk investments you can obtain directly from the US Treasury include bills, notes, and bonds. Keeping these instruments until maturity virtually guarantees that you will see a considerable return. The best part is that there is an investment level for all liquidity requirements. Bills will mature in 12 months or less, notes will mature in terms of up to a decade, and bonds can be obtained for terms as long as 30 years. The only way you can lose money on these is to sell them before they mature, which will cost.
No matter what, stocks will never be as low-risk as cash or government debt-based securities, but dividend stocks can offer a lower risk than other stocks and can be the start of significant passive income. The primary reason behind this is that dividend-paying organizations, as a whole, are far more mature and stable than companies focused on high growth. This provides you with stock ownership, where the stock value is somewhat insulated from the more significant volatility and value shifts that you see in other stocks, as well as dividend payments every month, quarter, or year.
Annuities, and fixed annuities, in particular, can be powerful ways to give you a place to park the money that can also generate income for you when the annuity matures. An annuity is a contract that you make with a large financial organization, such as an insurance company, that will pay you later in exchange for an immediate lump sum. Structured annuities can be configured in many ways, and can provide tax-deferred guaranteed income in the future for a predefined period, such as 30 years, or permanently until the client's death.
Also read: What Is Liquid Net Worth?
Understanding Liquidity In Your Investments Is Crucial
Some of the most important things to understand about new potential investments are the risk that they carry, as well as the degree of liquidity that they have. Low-risk investments may help you hedge against loss in value, those assets may have liquidity issues that leave you in a bind if you try to sell them when you need some cash and have no other options. Knowing what level of liquidity you may need in the short-term and long-term, as well as understanding your personal risk tolerance can help you pick investments that will compliment your portfolio while adding value and resilience.
More like this:
- Where Do Banks Invest Their Money? [ANSWERED]
- How to Start a Trust Fund [COMPLETE BEGINNER'S GUIDE]
- What Does Conditional Approval Mean? [ANSWERED]
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.