When you're investing money, "safe" is a relative term, and you need to understand that a certain level of risk always exists in all of your business ventures, no matter which investment vehicles you choose to put your hard-earned money into. Whether you're looking at ETFs, mutual funds, futures, quants, or a simple bank savings account – there's always a chance that your capital may fall through. That's why we have to take a look at two basics of the financial world before we can dive deeper into low-risk investments.
The Thing About Risk – It’s Not Quantifiable
Any meaningful discussion of returns, the stock market, or any other financial topic must bring up risk at some point. There simply is no investing without it. But as significant and important as the risk factor is, it's also very hard to grasp. Investors, finance experts, and robo-advisors alike have no one-fits-all definition or method to quantify risk. Meanwhile, economics scholars and academics have tried to narrow down the terms by using volatility as a proxy.
The term volatility means the likeliness of something to change unpredictably and quickly. In finance, it's a statistical measure for the level of dispersion of a certain investment instrument. This means the term represents the upswings and downswings of an asset's price around its mean price over a specific time period. The greater this range is, the more likely it is for you to buy an asset and have it's value suddenly drop.
But there is a fundamental flaw in this way of measuring risk. Although a higher volatility factor shows an investor that there's a greater range of good and bad outcomes for their investment, it doesn't affect the likelihood of the desired results. That's why turbulence on a flight is an excellent metaphor for volatility: although a passenger – the investor – may experience turbulence, it is not directly linked to the outcome of the flight. The plane could go through turbulence unaffected but still crash because of an electric failure in a turbine.
So, despite having volatility as a way of measuring the riskiness of investing by proxy, the question remains: What is investment risk? One definition of the term says that risk fulfills one or both of the following two conditions:
- An investment's under-performance in relation to the previously set expectations
- An investment's complete loss of all invested capital
If either one of those two statements (or both) are true, the investment can be said to entail a certain level of risk. And because an asset can always underperform or fall through, there is always a certain level of risk.
Let's look at a simple example. You invest in ETFs, expecting a return of at least 10%. The risk involved in this investment stems from the likelihood of it not being able to provide this return.
The level of risk in any investment is always relative to your financial goals and the characteristics of the investment assets. To understand the latter, we have to look at the trifecta of risk, returns, and liquidity – the magic triangle of the finance world.
No Risk, No Fun: The Magic Triangle of Finance
The second basic you have to keep in mind when looking for low-risk investments is the holy trinity of finance: profitability, security, and liquidity. These three factors are not only essential for evaluating any investment vehicle, but they're also three competing goals for any investor.
Security describes the risk attached to an asset, and profitability measures the gains which an investor can expect via interest rates, dividends, etc. Liquidity describes how easily accessible the capital you put into the asset is to you, meaning how easily you can withdraw from the asset and gain back the money you paid for it.
This trifecta of risk, returns, and liquidity has a certain kind of co-dependency as a baseline for their relationship, albeit a weird one. A good number in two of these always result in the third one being significantly worse. In effect, a highly liquid asset which yields significant financial gains AND is a low-risk investment is too good to be true.
Let's look at an example to make sense of the theory of risk. Let's say you want to invest x dollars, 50% of which go into a real estate development fund, while you invest the other 50% in quant hedge funds. The former yields significant returns after a long time – as soon as the real estate is fully developed. When the buildings are rented out and fully paid off, the money comes in, and you have created a reliable stream of income. On the one hand, your money is tied up in the project for an extended period of time – its liquidity is low, and selling your share of the project may be rather difficult because a buyer could not see the same interest rate and return margin as you. On the other hand, the prolonged timeframe and the relatively safe and stable real estate market significantly decrease the risk of this investment.
Your investment in CARL's quant hedge funds functions like a polar opposite to your other investment. Our quants offer higher 15%+ targeted returns, and thanks to the lack of lock-up periods, you can withdraw your money on a monthly basis, so liquidity is high. This means there will be no long intervals where you can't withdraw or re-invest your money. At the same time, the investment carries a greater risk than your real estate investment, as hedge funds, in general, are relatively risky. The stock market, futures, and other investment categories in which CARL quant hedge funds invest sometimes involve high-risk strategies to get you the returns you're hoping for. Thus, this increased risk comes with higher possible returns and greater liquidity, which other investment opportunities can't offer.
The concept of the finance triangle is simplified and it's used as an easily understandable and accessible way to explain financial correlations.
Taking into account the triangle theory, a low-risk investment usually involves choosing a safe route to increase your wealth. Generally, there's less at stake when choosing investment options with lower risk. This goes two ways; there is a lower likelihood of losing all of your capital with the investment, but the liquidity or profitability of the investment may also be very low. Whether you choose short-term or long-term solutions is up to you and depends in part on how long you can do without access to the sum of money you invest.
Examples for low-risk investments
Historically, US government municipal bonds and corporate bonds have been very safe investment options. There is very little chance that either investment type will fail to achieve its expected interest rates and returns. But there is a certain level of security because a state is much less likely to be unable to pay than a privately owned company.
Another classic is the old-fashioned savings account, but recent years have made simply saving money less and less effective at growing your wealth, as interest rates have diminished across the board. You can actually lose purchasing power if you simply keep your money in a savings account, as inflation rates have long since outpaced the interest rate on most savings accounts.
The third type of low-risk investment is money market accounts. They use capital to invest in debt securities with short terms like treasury bills or municipal bills. Their short-term characteristic provides for low risk and offers a fixed income which is paid as a dividend. One drawback to these is their susceptibility to the volatility of the money market as well as their lack of FDIC insurance. So while they're a relatively safe option for investing, a money market account can fall through, and the FDIC won't pay back your loss.
What's the connection between low-risk investing and CARL?
The connection lies in the magic word "diversification". If you want to accumulate wealth – short-term or long-term – a diversified investment portfolio is key. Setting yourself up with low-risk options because you want to play it safe will not bring in the returns you want when you put aside money for investments. But low-risk endeavors like money market funds and other safe investment strategies, combined with CARL's high-yield but more risky quant hedge fund strategies make a well-rounded portfolio. Sign up to the CARL app today, transfer money into your account and start enjoying higher returns and worthwhile interest rates to grow your wealth!