Hidden Risks of “Low Risk” Investments

Low Risk Investments

Terms like low risk investments instill an innate sense of security and comfort; this is similar to opting for a sturdy but ancient car that may lose its racing edge but assures you of safety from point A to point B. Just like that old car could have hidden engine problems, low-risk investments too come with their own set of hidden risks.

This blog will cover hidden dangers, including interest rate risk, inflation risk, liquidity risk, credit risk, and many others that could quietly erode your money. We will also present relatable examples so that you may easily connect the dots.

What Are Low Risk Investments? 

Low-risk investments are types of financial products considered safer and more stable than stocks or cryptocurrencies. Here are some:

• Savings accounts
• Certificates of Deposit (CDS)
• Government bonds
• Money market funds

They offer smaller returns, but there is a very small chance of loss of principal. But-and that is a huge but-low risk does not guarantee no risk.

The Hidden Ones in Risks That You Must Watch Out For

1. Interest Rate Risk

Locking up your savings in one of those 5-year fixed deposits earning interest at a rate of 4%, and next year, the banks are coming up in the race with 7%. You’re stuck, as while you earn a smaller interest, others are earning more. Interest rate risk is when your already existing investments are being devalued with the rise in rates.

2. Inflation Risk

That’s ₹200 for a movie ticket today. Your investment is growing at 3% each year, but inflation grows at 6%. You are really going backwards. Specifically, inflation risk means the actual returns decrease because the prices for living have risen much faster than those earned from investment.

3. Liquidity Risk

Say you are stuck in urgent need of cash, and your money is locked up in a 5-year government bond. You can’t access any or you have to sell it at a loss. This is liquidity risk inability to quickly convert investments to cash without taking a hit.

4. Credit risk and Default risk

Risk, both with credit and default, occurs even in government or corporate bonds. Example: You lend your friend ₹10,000 expecting it back in a month. If he loses his job and can’t repay you, that’s a default. Similarly, companies can default on bonds. Even so-called “safe” investments are only as strong as the institution behind them.

5. Reinvestment Risk

Consider an investment: a 7% bond, which, upon maturity, will bring about only 4% returns from the newly issued bonds. The reinvestment of the money, therefore, should earn less income, and this is reinvestment risk.

6. Market Risk

Even the so-called safe assets can be subject to fluctuations. When the rates of the market rise, the price of government bonds lowers. It is like you bought a brand-new phone, and two months later, the price cut was announced. It might be cheaper, but you have the phone.

7. Regulatory Risk

Sometimes, the government can decide on new rules overnight.

 Whenever a new tax or policy impinges on your cooperation with an investment, it alters the profitability of that investment. It’s like planning a weekend trip and suddenly realizing the roads are closed.

8. Opportunity Cost

You might lose out on other higher-growth opportunities if you keep on investing only in safe bets. Just think of someone saying he would never try any of the cool flavours because he’s always going for plain old vanilla ice cream! Opportunity cost is the cost of the next best alternative. 

9. Currency Risk

The value of the returns from your investment could be reduced due to fluctuations in currency rates if you have invested in foreign bonds or funds.

 Let us say there was an investment made into a US fund; however, the dollar was weakening against the rupee. Even if the fund rises, your rupee redemption could end up being less.

 That is how currency risk works. 

10. Psychological Risk

Fear, impatience, and greed can conspire against good choices. 

During the market crash due to COVID in 2020, many got panicky and sold their investments-were huge amounts of losses. 

When investing, the mind could be your worst enemy- psychological risk.

11. Concentration Risk

Putting all your eggs in one basket-and all the investment in one \”safe\” place-would backfire when that safe place gets into trouble. 

If the basket drops, you lose all the eggs.

12. Counterparty Risk

Simply put, that’s the risk that the counterparty you made an agreement is unable to perform its side of the bargain. 

Imagine pre-ordering a product online and the shop goes bankrupt. No delivery, no refund. 

In the same way, if the bond issuer or insurer goes bankrupt, your money could be at risk.

13. Economic Downturn Risk

A recession can spill over even the so-called “safe” assets. 

Government earnings drop, and companies shut down. That’s what can cause a bank FD to offer low-interest rates or limited access! 

Once the markets tumble under recession, very few investments remain unaffected.

The day-to-day life analogy is that of the “Safe” Umbrella.

 Even a low-risk investment is considered similar to buying an umbrella to safeguard oneself from a rainy season. Most of the time, it tends to safeguard a person. However, there may be a day when the wind is strong and the umbrella will become a broken flip. That is how the investments can be safe; still, some hidden forces can affect them unless you are careful.

Protective Measures for Yourself

Diversity should begin with alternative investments.

• Knowledge is essential regarding inflation and interest rates.
• Retain some liquid funds for days of emergencies.
• Being true to your risk tolerance level.
• Reassess the portfolio every six months to make necessary adjustments.
• If one is simply cautious, it can become being prepared.

Final Thought

They can be a crucial part of the diverse portfolio, especially put away for short-term objectives or particularly risk-averse individuals. 

But do not fall into the trap of thinking “low risk” equals “no risk.” 

Understanding “hidden” interest rate risk, inflation risk, and liquidity risk aids in making smarter and stronger financial decisions.

Because, like in finance, the things you don’t see coming often really have the biggest impacts on experiencing life itself.

Are you all set to Invest Smartly?

We believe success in finances comes from understanding the reward side and risk side. Our expert advisors help you design a portfolio balancing safety, growth, and intelligent risk management so that you can invest with confidence, not fear.

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Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.