Low Risk Investment

How to Look at Investment Property Risk

Many people search for a low risk investment with high rates of return. However, there is a strong correlation between risk and return on investment. Other people looking to get rich quick will try to find a high risk investment with a very high return. So how much risk Vs reward should you strive for?

Two of the biggest shortfalls in most financial strategies is to either put too much of ones investments into one investment category or to ignore the risk of losing your principle to inflation.

Most people looking for a low risk investment will put their money into either low yielding bonds or bank Certificates of Deposit (CDÂ’s). Those with enough capital will look at US Treasury Bills as being the safest of all investments.

I see two flaws in this low risk strategy of investing:

• Governments increasingly are showing that they will print money (fiat currency) without regard to consequences - this puts everyone holding fixed income investments at high risk of principle devaluation. In this regard, Treasury Inflation Protected Securities (TIPS) are one way to compensate for inflation risk.



• Governments can seize companies and invalidate the bondholders equity (see how Chrysler bondholders were screwed by the US Government)

At the other end of the spectrum of investment risk, some investors look for high risk investment and chose commodity futures or option trading to satisfy their need to gamble. While this could be part of your investment strategy, it should not be the whole financial plan.

Investing in the stock market is somewhat less risky but many companies go out of business and owning individual stocks (Enron and MCI to name two large companies that went bankrupt) can cause your account to go to zero value. I had a brother that was in the ground floor of a high tech startup. His fortune went from zero to millions and back to zero.

Gold is now touted as a great hedge against government expansive printing of fiat currencies. However, gold ownership does not pay dividends and its value has at times fallen dramatically.

So where does investment property fit in the list of risk and return? If you own your property outright, investment risk is fairly low and may be a lower risk investment then a corporate bond. A rental property that is highly leveraged is risky in the sense that you can easily lose the property if you do not have cash reserves when you lose a tenant. On the other hand, the risk of the property value going to zero (assuming you carry fire insurance) is fairly low.

So how to rate risk and return on investment?

1. Treasury Bills - low risk of losing capital, high risk of losing value to inflation, low return



2. TIPS - lowest risk and lowest return



3. Gold - low risk and a return that over the long term keeps pace with inflation


 


4. Corporate bonds - fairly low risk and average returns



5. Stocks index funds have medium risk and average returns



6. Fully owned investment property - medium risk and average return



7. Leveraged real estate investments - slightly lower risk then stocks but higher returns



8. Individual stocks can range from low to high risk with low to very high returns



9. Junk bonds - high risk and high return



10. Commodity futures - very high risk and very high return potential

On the whole, it pays to diversify your risk. This means not just buying large cap Vs small cap stocks. This means owning a piece of at least 5 different investment vehicles listed above. Remember, that losing your capital to inflation is just as bad as losing value in your stock portfolio. A low risk investment is not necessarily the lowest risk investment.

It should be clear that using leveraged investment property has a very good risk to reward ratio and, while not a low risk investment, is an essential part of any good investment strategy.

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