What is the most risk-free way to invest a lump sum of cash for 1-2 years? [duplicate]

Question

I received a signing bonus with my most recent position for which, if I leave the company after one year I must return half, and can keep the entire amount if I stay two years. I am a very risk-averse person so I don't want to spend the money and be completely locked in if I decide I want to leave.

My question is - where can I put this cash such that it will gain the maximum amount of interest with nearest-to-zero risk and decent liquidity? Since the case in which I would actually need to withdraw it would necessitate me returning much of it, it would be important to have access to almost the entire sum (I could sustain a 10% drop say, but 30% would be a real kick in the teeth).

I've been looking at CDs and bonds, it is my understanding that bonds would perform better in a low-inflation environment like the one we're in, but I am unsure and also looking for other investment vehicles to consider.

Answer 1

CDs will give you the best return with zero risk. Bonds will lose value if interest rates go up, unless you buy risk-free treasury bonds that expire in 1 and 2 years. I doubt the return on those will be any better than CDs, though.

If you are just interested in preventing loss, another option would be to invest in index funds and buy put options that expire in one year to limit your loss. Since you can "sustain a 10% drop", you could buy out-of-the-money put options with a strike around 10% lower than the current price, which protects you from a loss and lets you keep any gain.

The downside is that options cost money upfront, and you don't get that money back, but you're guaranteed not to lose any more and you get to keep any profit made if the market goes up over the next few years.

Another option is to use the money to pay off any high-interest debt, and put the payment you're not making anymore in a savings account. You'll get an instant return of the interest rate you're paying (since you're not paying that interest anymore) and can use the cash flow savings to save up in case you need to repay it.

Answer 2

Interest with zero risk means cash equivalents (money market and CDs). Treasuries and investment grade bonds that mature in your time frame would also qualify except that the value of the principal may decrease prior to maturity if interest rates rise.

Investment grade preferred stocks would provide about 5% yield but like bonds, their value is tied to interest rates. That means that their value will fluctuate. For the most part, they're fairly stable but occasionally there are deep corrections (see 2008 and March of this year). If you prefer ETFs to individual issues, some examples are PFF, PGF, FPE, PSK, etc.

If you are bullish on the market and you would like equity exposure with limited potential gain and controlled risk, opt for no/low cost collared long stock (or ETF). This entails selling an out-of-the-money call and using the proceeds to purchase an out-of-the-money put. The call's strike price is your upper profit limit and the put is your lower loss limit. You can tailor the amount of risk and reward that you are comfortable with. If you want less risk or greater profit potential, the out of pocket cost will be higher. For example, an 11 month SPY collar that is 10% wide on each side would cost you about $6 today, above and beyond share cost.

Note that this strategy is equivalent to a vertical spread which is the preferred approach. I have described the collar because many people can conceptualize that description better.

Understand that risk and reward go hand in hand. If you want more reward, you have to take on more risk.