Are investments with no risk possible? Financial instruments with no risk are not subjected to price fluctuations. These are the short-term instruments often guaranteed by the government and characterized by relatively low income, slightly exceeding the level of inflation. These instruments are sold without fees.
Money Market Instruments
Money market instruments are short-term fixed income securities (from 1 to 270 days) such as Treasury Bills, commercial paper (short-term corporate lOU’s), banker’s acceptances, money market funds, and short-term loans by industrial corporations and banks.
• The goal of buying them is to “park” your money until the time long-term investments will yield a better total return.
• The advantage of these instruments is their liquidity and lack ol market risk. They compete with savings accounts which produce a similar income.
• The disadvantage of these instruments is a relatively small income. Most of the investment banking firms don’t charge any fees to buy them. They are considered to be one of the safest investments. The minimum capital required is $500.
Certificates of Deposit (CDs)
CDs are term deposits in banks and thrift institutions. When buying certificates of deposit an investment is frozen for a certain maturity spanning 30 days to 10 years, and in return a fixed or variable yield is provided.
• The advantage of certificates of deposit is a guaranteed income which is higher than a savings account income by 1% to 2%. Certificates of deposit with longer maturities produce higher income.
• The disadvantage of certificates of deposit is the lack of liquidity. Premature withdrawal of a certificate of deposit is usually penalized by a reduction in the income paid (usually 10%).
• Certificates of deposit are considered one of the safest financial instruments.The minimum investment ranges from $500 to $5,000.
Annuities – no risk investment
An annuity is a contract in which a sum of money is deposited for a specified period of time with an insurance company. The insurance company promises to pay interest which accumulates within the annuity without current income taxes. Then, at a predetermined date in the future, the insurance company returns, in full, payments of principal and interest. Annuities insure that we have money at our old age.
There are immediate and deferred annuities. Immediate annuities vest immediately and pay usually after 30 days. Deferred annuities pay at some point in the future.
There are also fixed and variable annuities. With a fixed annuity, the issuing insurance company guarantees a fixed interest rate for a specified period of time (generally one to seven years). After this time, the interest rate is adjusted periodically.
The variable annuity is similar to a mutual fund. The insurance companies invest in stocks, bonds, government and money market securities according to the wishes of the owner of the annuity. Although the return on these annuities vary, they have traditionally provided higher returns than fixed annuities. Even though the money is invested in stocks and bonds and thus subject to a market risk, the issuing insurance company guarantees the entire principal to the beneficiary in the event of annuitant death.
The main advantages of annuities are:
• Absolute safety of capital, which is guaranteed by both the insurance company and the state government of the residence of the annuity owner.
• Tax deferral on earnings until they are withdrawn from the annuity. The annuity payment is in part a return of capital and in part a return from the accumulated earnings throughout the years. The return of capital is not subject to taxes but the earnings are taxed,
• Positive effects of interest rate compounding, i.e. the investor gets interest on interest.
• A high yield. To illustrate, let’s compare a purchase of an annuity with a purchase of a certificate of deposit of $40,000 yielding 8.25%. After ten years, the tax deferred annuity will grow to $88,377, but the taxable certificate of deposit will grow to only $71,229 (with an assumption of a 28% taxable rate).
• Liquidity of investment. The investor may liquidate part or all of his annuity at any time. Once a year the investor may withdraw 10% of his pay-in capital without any penalty. If he chooses to take more, he will typically pay a penalty of 6% the first year, 5% the second year, and 4%, 3% and 2% and 1% after the third, fourth, fifth and sixth year. There aren’t any penalties after seven years.
• Choice of annuity payments. The owner of an annuity may request a one time lump sum payment, a term annuity, or a life annuity.
In the case of a term annuity, the period fluctuates between five and thirty years. After the end of a selected period, annuity payments stop. If the owner of the annuity dies during the period of the term, the insurance company continues to pay the agreed upon installments to the annuity owner’s beneficiaries.
These are most common types of investments that bear no risk at all.