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How to invest

The risk of different investment types

The 3 main types of assets all have different levels of risk and potential reward. You can mix them in order to lower your chance of losing money.
5 minute read

Points to know

  • Of the 3 main asset classes, cash is the safest, followed by bonds and then stocks.
  • Safer investments also have lower average returns.
  • By mixing investments, you can get a balance of both stability and growth potential.

What are the 3 asset types?

Cash (short-term reserves) & money market funds

Main goal: stability. You probably won't lose money with these investments, but you won't gain much either.

Main risk: The rate at which you earn money could be lower than the rate of inflation.

Average return over time: 3.5% a year before inflation, 0.6% a year after inflation.*

Percentage of years with a negative return: 0%.

Find out more about cash
 

Bonds & bond funds

Main goals: getting a moderate return in exchange for a moderate amount of risk; getting a stream of income; offsetting the larger risk of stock investments.

Bonds can be domestic (from the United States) or international. Having both in your portfolio helps spread out your risk even more.

Main risks: Because bond prices and interest rates move in opposite directions, rising interest rates could push bond prices down. The bond's issuer could stop making promised payments or be unable to repay the principal.

Average return over time (for U.S. bonds): 5.5% a year before inflation, 2.5% a year after inflation.*

Percentage of years with a negative return: 16%.

Find out more about using bonds for income & stability
 

Stocks & stock funds

Main goal: getting a larger return in exchange for a larger amount of risk.

Stocks can also be domestic or international. As with bonds, it's smart to consider holding both.

Main risks: Stock prices could drop for a variety of reasons, including poor performance of certain companies and concern about the economy. Dips in the stock market tend to be worse than in the bond market.

Average return over time (for U.S. stocks): 10.2% a year before inflation, 7.1% a year after inflation.*

Percentage of years with a negative return: 28%.

Find out more about using stocks to add the opportunity for growth

How does mixing investments lower risk?

As you can see, stocks, on average, have the highest potential return. Adding bonds tends to shrink the range of possible outcomes you could face every year—creating a lower opportunity for returns but also a reduced risk of loss.

If you have a long timeline (10 years or more) and a very high risk tolerance, you might be fine with an all-stock portfolio. But if you need your money in less than a year or you're very conservative, you might need to keep your money in cash.

If you fall somewhere in the middle, your portfolio should be made up of a variety of asset types, giving you a more moderate level of portfolio risk.

Find out more about getting the right asset allocation

Adding bonds tends to lower both risk and potential return

Source: Vanguard. Best and worst calendar-year returns from 1926 through 2014. Stocks are represented by the Standard & Poor's 90 Index from 1926 to March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Wilshire 5000 Index from 1975 through April 22, 2005; the MSCI US Broad Market Index from April 23, 2005, to June 2, 2013; and the CRSP US Total Market Index thereafter. Bonds are represented by the S&P High Grade Corporate Index from 1926 to 1968; the Citigroup High Grade Index from 1969 to 1972; the Barclays U.S. Long Credit AA Index from 1973 to 1975; the Barclays U.S. Aggregate Bond Index from 1976 to 2009; and the Spliced Barclays U.S. Aggregate Float Adjusted Index thereafter.

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*All average return data covers the period 1926–2014. For U.S. stock market returns, we use the Standard & Poor's 90 from 1926 through March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Wilshire 5000 Index from 1975 through April 22, 2005; the MSCI US Broad Market Index from April 23, 2005, through June 2, 2013; and the CRSP US Total Market Index thereafter. For U.S. bond market returns, we use the S&P High Grade Corporate Index from 1926 through 1968, the Citigroup High Grade Index from 1969 through 1972, the Lehman Brothers U.S. Long Credit AA Index from 1973 through 1975, the Barclays U.S. Aggregate Bond Index from 1976 through 2009, and the Spliced Barclays U.S. Aggregate Float Adjusted Bond Index thereafter. For U.S. short-term reserve returns, we use the Ibbotson 1-Month Treasury Bill Index from 1926 through 1977 and the FTSE 3-Month Treasury Bill Index thereafter. Inflation is measured using the CPI-U.

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. Investments in bonds are subject to interest rate, credit, and inflation risk. Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.