Capital Growth vs. Capital Preservation

Capital growth and Capital preservation are sound investment strategies. Yet, they are entirely different approaches to investing. Before deciding between the two, you should understand the trade-offs, tax implications, market dynamics, and pitfalls of each approach.
After you finish this article, you should know the following:

• How to compare capital preservation vs. growth
• Their relation to risk tolerance and risk management
• Their advantages and disadvantages
• Which strategy may be right for you

What is Capital Growth?

fig 1. Capital Growth

Capital growth is an investment approach that focuses on increasing the value of your investments over time. You can measure capital growth by calculating the difference between an investment's current value, V2, and its original purchase value, V1: delta = V2 - V1.

The following simple formula can calculate returns on investment:

Return On Investment, ROI = 100%*(V2-V1)/V1

Example:

V1, original purchase price $100 on January 1st, 2020
V2, the new market price of $120 on January 1st, 2023

ROI=100%*(120-100)/100=20%

Note: The 20% ROI is the total growth over three years of the investment; most rates are annualized.
In a simple calculation, you can divide 20% by 3 to obtain an annualized return on investment.

Most investors use a capital growth strategy to invest in equities and tangible assets with moderate to high growth potential. 
Since capital growth investments can deliver high returns in exchange for higher risk, investors with a high risk tolerance and the willingness to hold an asset for an extended period gravitate toward a capital growth asset allocation.

Some growth investors may only sell their growth investments to pass them on to their heirs (long-term growth).
Moderate-growth portfolios primarily hold equities in well-established companies such as Amazon (AMZN) and Microsoft (MSFT).
Conversely, high-capital-growth portfolios typically hold more speculative assets, such as Meta Platforms (META) and Qualcomm (QCOM).

What is Capital Preservation?

Capital preservation is an investment strategy focused on protecting capital and preventing portfolio losses. Investors execute this strategy by primarily investing in ultra-secure short-term investments, such as certificates of deposit (CDs), savings accounts, and Treasury bills. The primary financial objective of this passive investing strategy is to keep pace with inflation.
Capital-preservation investments typically appeal to investors who lack the time or resources to recover from significant asset losses. This characteristic is why most retirees favor capital preservation; they don't want to outlive their savings.

What Does Risk Tolerance and Risk Management Have to Do with It?

The current income from high-yield bonds and dividend-paying stocks appeals to investors with low risk tolerance (risk-averse) because they value a quick, predictable return, even though the real rate of return can be meager or near zero.
Since they prioritize capital preservation and portfolio protection, risk-averse investors view the low-risk, passive income stream as worth the trade-off against the potential for higher returns from growth investments.
On the other hand, most growth investors place little value on current income, favoring capital appreciation. Their high risk tolerance makes them willing investors in riskier growth stocks with high price-to-earnings (P/E) ratios.

However, most capital growth investors aren't stock market daredevils. Instead, they mitigate risk through extensive research, portfolio diversification, and dollar-cost averaging. In addition, they can tailor their asset allocation to their risk tolerance and projected investment horizon.

Capital Growth Advantages

Capital growth offers advantages that can advance your objective. However, it has disadvantages that could impede or deconstruct your investment activity. Here are the most prominent advantages and disadvantages of capital growth.

• Tax Benefits
  Capital growth assets are long-term investments. So, even if one of your assets appreciates exponentially in a year, you won't need to pay taxes on the gain unless you sell the asset. Additionally, experienced real estate investors can claim a tax deduction through a complex negative gearing strategy.
• Great Profit Potential
  If your capital growth strategy works, you could benefit from impressive returns. For example, Microsoft shares traded at an average price of $15.49 per share in 1998. Currently, Microsoft shares trade at an average price of $241.22 per share. So, if you had invested $5,000 in the company's shares in 1998, your shares would be worth $77,860.99 today.

Capital Growth Disadvantages

• Substantial Opportunity Cost Risk
  Many capital growth assets have low liquidity, leaving you open to opportunity cost risk. Opportunity cost is the value of the next-best alternative. For example, suppose you chose to invest $160,000 in California real estate instead of gold in 2001, and in 2021 you sold the investment for a $805,100 net profit. However, if you had invested that amount in gold at the time, your investment would be about $923,200 today. Your opportunity cost would be $118,100.
• High-Risk Factor
  Unfortunately, not all capital growth investments are Microsoft success stories. Only a small percentage led to a 20-year investment horizon.

For this reason, asset volatility is a critical concern with capital growth investments.

Capital Preservation Advantages

• Minimal to Low-Risk Levels
  Short-term, fixed-income investments like CDs and U.S. Treasury notes offer low-stress capital-preservation investing. Most of these fixed-income investments are government-backed. Some investors also use a capital-preservation strategy to safeguard their capital until market conditions improve.
• Safe and Stable Returns
  Capital-preservation investments such as government bonds and money market accounts are the safest and most stable. Also, you are not required to do due diligence or management duties.

Capital Preservation Disadvantages

• Lack of Options
  Due to volatile domestic and global market conditions, the list of capital-preserving markets is getting smaller. In addition, current inflationary pressures contribute to the problem.
• Minimum to near-zero returns
  Volatile market conditions make finding capital-preservation investment options that offer a decent return difficult. As a result, you end up settling for fixed-income investment options with very low or near-zero returns.

Which is the Best Strategy for You?

At this point, you should thoroughly understand how these investment approaches can fit into your investment plans. For example, capital preservation is your best investment strategy if you want to play it safe with your investment portfolio. Alternatively, you can always switch plans or use a combination if your situation changes.

Frequently Asked Questions

How Much Money Should I Commit to Growth Capital Investments?

The amount of money you commit to a capital growth investment is entirely up to you. However, since these assets have a long-term investment horizon, experts advise investing in growth with money you can do without for at least five years.

Can I use a growth and preservation objective at the same time?

Yes, you can use both strategies simultaneously. However, you may need to reassess your goal before proceeding, as you will not be pursuing a core objective.

Is a capital growth objective more successful than a capital preservation strategy?

Considering the widely accepted premise that long-term returns can overcome short-term volatility, a capital growth strategy has better potential to be more successful than a preservation strategy, especially when factoring in inflation.

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Related information		How Do Smart Investors Benefit from Capital Preservation? Is Capital Growth the Best Strategy for You?