Investor Education Centre > Useful Tips & Knowledge > There’s no such thing as 100% Safe investments that produce income
There’s no such thing as 100% Safe investments that produce income
Investments that provide a steady, stable, passive income stream are highly-prized, especially when you are planning for retirement. Once you’re no longer earning an income from a job, a lot of people rely in part on their investment income. Many retirees are especially focused on “safe” investments – that is, investments that present very little risk of dropping dramatically in value and negatively impacting their retirement nest egg.
The reality though is that the search for a perfectly safe type of investment is a fruitless one; that proverbial golden goose just does not exist. Whether you’re investing in a government bond, term deposit or some other income-producing investment, they all come with various types of risk. Here are some of the most common that you should keep in mind when deciding what to do with your money.
Liquidity risk refers to the fact that an investment cannot be easily bought or sold quickly enough to prevent a loss or make a profit. Government bonds and term deposits are both subject to liquidity risk, as are other types of investments that require a minimum locked-in period before they can be sold off.
Interest Rate Risk
Interest rate risk refers to the impact that rising or falling interest rates can have on associated investments. When interest rates rise, for example, newly-issued bonds become more attractive since they are issued at a correspondingly higher interest rate.
Rising interest rates also have the undesirable effect of making previously-issued bonds less attractive since they were issued at a lower interest rate that is now below market value.
Political risk refers to changes to a country’s policies that govern businesses and influence investments. A good example would be changes to a country’s taxation scheme that raise interest rates for a specific market segment or industry.
More severely, a declaration of war or military coup would also fall into the definition of political risk. While that scenario is relatively unlikely in a country like Australia, it is still a consideration. Don’t let anyone tell you that government bonds are risk-free!
Inflation risk refers to the chance that income streams in the future won’t be worth as much in a few years as they are today due to the eroding effect of inflation. Investors who prioritise the minimisation of risk over the quality of their investment returns are especially vulnerable to inflation risk.
For example, if you invest in a government bond that pays 2% per annum in income, but inflation averages 3% per annum for the same time period, then you’re not actually making any money in real terms; you’re losing it. That’s inflation risk in action.
Any income-producing investment presents an element of risk; that risk is exactly what you as an investor are being compensated for in the form of income. The most important thing any investor can do is, not to avoid risk entirely, but to take the time to carefully understand and evaluate an investment’s risks and make a calculated choice to accept certain smart risks for the prospect of earning a respectable return and income stream.
This website contains general information only and is not intended to provide any person with financial advice. It does not take into account any person's (or class of persons) investment objectives, financial situation or particular needs, and should not be used as the basis for making investments.