What is Risk-Free Investment?
A risk-free investment is a theoretical investment with zero risk of losing the principal amount invested, such as Treasury bonds issued by the US government which are considered to have a low level of risk compared to other investments.
Consequently, the return on risk-free investments is often used as a benchmark for determining the risk of other investments.
The idea is that by investing in a risk-free asset, an investor compare the return of other investments to the return of a risk-free investment and determine whether the potential reward is worth the added risk.
However, it’s important to keep in mind that no investment is truly risk-free. Even Treasury bonds, which are considered to be among the safest investments, carry some level of risk, such as the risk of inflation eroding the value of the investment over time. Additionally, the creditworthiness of the issuer is always a consideration, even with government-issued bonds.
What Kind of Investment is Considered Risk-Free Investment
Traditionally, Treasury bills (T-Bills), have been considered to be risk-free investments because they are issued by the government and are backed by its full faith and credit. This means that the likelihood of the government defaulting on its debt obligations is considered to be extremely low.
In addition to Treasury bills, other low-risk investments include:
Savings Accounts: Savings accounts are considered low-risk because they are insured by the Federal Deposit Insurance Corporation (FDIC), which means that depositors are protected up to $250,000 per account in case the bank fails.
Certificate of Deposit (CDs): CDs are considered low-risk because they are issued by FDIC-insured banks, meaning that the depositor’s funds are insured up to $250,000. Additionally, the rate of interest on a CD is fixed for the term of the deposit, which provides a predictable return.
Municipal Bonds: Municipal bonds are considered low-risk because they are issued by state and local governments and are backed by the taxing power of the issuer. This means that in the event of a default, the issuer has the ability to raise taxes to pay its debt obligations. Additionally, the interest earned on municipal bonds is often exempt from federal income tax, which can make them an attractive investment for tax-sensitive investors.
Corporate Bonds: Some highly rated corporate bonds can be considered low-risk investments because they are issued by established companies with a strong financial history and a good credit rating. These bonds are generally considered to be less risky than stocks because the issuer is obligated to make regular interest payments and repay the principal at maturity.