What is Capital Preservation? Capital preservation strategies.

Capital preservation is a conservative investment strategy that many investors use to preserve and protect their assets. Learn how it can help you.

last updated Saturday, April 13, 2024
#capital preservation #what is capital preservation

John Burson

CONTENTS

Capital preservation is a popular investment strategy for conservative investors because it uses a risk-mitigating and protective approach. But, like its counterparts, this investment strategy has limitations and conditions. By covering all the details and concerns, this article will help you decide whether capital preservation is your best investment strategy.

What is Capital Preservation?

Capital preservation is a conservative investment strategy emphasizing preserving capital and preventing a decline in portfolio value. As such, this strategy concentrates on investing in low-volatility short-term investments like certificates of deposits and treasury bills. These conservative investment instruments offer a consistent yield with little to no risk.

Types of Capital Preservation Investments

preservation of capital

Institutional and individual investors concentrate on low market volatility when choosing securities for their capital preservation strategies. Some investments that meet this criterion are:

Money market funds
Savings accounts
Checking accounts

All these investments feature Federal Deposit Insurance Corporation (FDIC) insurance for up to $250,000.
If you can commit money for several months, FDIC-backed cash deposits (CDs) and short-term Treasury bills are viable capital preservation investment options. Also, you can invest in U.S. Treasury Inflation-Protected Securities.
For a longer cash commitment of a few years, you can advance your capital preservation strategy with the following:

Short-term municipal bonds
U.S. agency bonds
Short-term corporate bonds

Who are Capital Preservation Investors?

Risk tolerance is a significant factor in investment objectives. Investors with higher-than-average risk tolerance tend to invest in growth stocks with high price-earning (P/E) ratios but high volatility. In contrast, investors with a low-risk tolerance (risk-averse) tend to buy equities with stable returns with little or no risk.

However, from an investment standpoint, risk adversity can be more than an emotional/psychological response. Circumstances are often the primary reason investors accept smaller returns in return for more asset protection and preservation. Here are two examples of investors who use capital preservation strategies.

Real-life Example 1: Tim and Nancy

Tim York and Nancy Black are friends. Tim is a retired chemical engineer with a good pension plan, but he relies on his investments to generate income to maintain his pre-retirement lifestyle.
On the other hand, Nancy is still working as an accountant and building her retirement nest egg. She owns rental property that generates net income for her retirement package, but she wants to diversify her investment portfolio in case real estate tanks soon.
Tim and Nancy most likely practice a capital preservation strategy. Both are in a life stage where they don't have the time or resources to recoup a significant loss in asset value. So, they tend to gravitate toward government-backed securities and capital preservation funds.

Real-life Example 2: Luther

Luther is a 32-year-old man who works as a school nurse. Unfortunately, his parents died in a tragic accident, leaving him a sizeable estate, including a lucrative investment portfolio. Luther has no retirement plan of his own and no investment experience.
Over the years, Luther has seen friends squander their inheritances on risky investments and ventures. And he doesn't want to suffer a similar fate. So, he's hired a financial advisor to help form a capital preservation investment strategy.

Advantages of Capital Preservation Strategies

Capital preservation assets are safety-first investment instruments that yield marginal but predictable returns without tactical maneuvers by the investor. They don't require much investor expertise to manage.

As a result, investors:

Don't need much investment experience to buy capital preservation assets
Work and live without constantly checking market fluctuations through financial media
Are confident their investments are safe

Disadvantages of Capital Preservation Strategies

Inflation is a bad word in finance. And it can be a major spoiler if you use the preservation of assets strategy. It can eat up your returns on fixed-income investments. You may experience this inflation-related loss because fixed-income investments pay out a nominal interest rate that doesn't adjust for inflation. So, your interest rate from a fixed-income investment is the nominal rate minus the inflation rate.

For example, on May 15th, 2023, the U.S. 1-Year Treasury Note offered 4.63% (nominal rate). And the annual inflation rate was 7.7%. So, if these numbers stayed consistent for a year, your actual interest rate would be negative 3.05%. This powerful impact of inflation on your capital preservation assets is why it is a short-term strategy.

Is Capital Preservation Your Best Investment Choice?

Your best investment strategy depends on your time constraints and risk tolerance. For this reason, a capital preservation strategy may be right for you if you fear losing your investment assets. Conversely, a growth strategy may be best if you can assume significant capital risks and longer capital commitment in exchange for higher gains.

However, your options don't have to be an either/or situation. For example, trading risky securities while separately saving for retirement is possible. Also, your risk tolerance may shift over time, motivating you to rebalance your investment portfolio.

FAQ

Are there any alternative capital preservation investments?

Wealthy or sophisticated investors may adopt a capital preservation strategy that includes alternative investments. Assets like rare coins, gold, and fine art hold value even in the most challenging financial times. Also, gold has a negative correlation to the stock market.

How to invest in capital preservation assets?

An asset's suitability for a capital preservation strategy depends on its volatility. Volatility defines the price fluctuations of a security over a specified period. Since low volatility and minimal-risk securities are ideal for preserving capital, you should limit your search for capital-preserving investments to government bonds, savings accounts, inflation-adjusted accounts, and treasury bills.

What is the best real estate asset for capital preservation?

Investors using a capital preservation strategy prefer core real estate properties because these properties are steady income-generating assets. Also, compared to value-add or opportunistic real estate, core properties are less risky, especially with a diversified approach across geographical markets and property types.

How to preserve capital?

There are several strategies you can use to preserve capital:

Diversify your investments.
By spreading your money across different asset classes and investment vehicles, you can reduce the overall risk of your portfolio and help preserve your capital.
Avoid excessive risk.
High-risk investments may offer the potential for higher returns, but they also carry a higher risk of loss. It's crucial to find a balance between risk and return that you are comfortable with and to avoid taking on too much risk with your capital.
Maintain an emergency fund.
It's essential to have a cushion of cash in case of unexpected expenses or emergencies. This can help you avoid selling investments at a loss to meet your financial needs.
Keep a long-term perspective.
Short-term market fluctuations can be volatile and unpredictable. By maintaining a long-term view and not panicking in response to short-term market movements, you can help preserve your capital.
Consider working with a financial advisor.
A financial advisor can help you create a personalized investment strategy that considers your financial goals and risk tolerance and can help you make informed decisions about how to preserve your capital.