When selecting assets for a portfolio, it’s important to consider an investor’s risk tolerance. While some investors are willing to take on more risk to achieve a greater return, others may forgo any risk to preserve their capital. Capital preservation is what it sounds like – an investment strategy that preserves your money. So what’s the best investing strategy to make sure that you don’t lose any of your money?
What is Capital Preservation?
Capital preservation is an investment strategy that aims to preserve capital and prevent loss of a portfolio. When using this investment strategy, investors opt for safe assets such as Treasury bills and certificates of deposits (CDs). Investors who use this strategy tend to be risk-averse and have a short time horizon. Often, retirees or those approaching retirement will use this investment strategy to preserve funds to support their lifestyle after they stop working.
Capital preservation investors generally have a limited amount of time to recuperate their losses from a market dip or recession. They choose to give up potential returns in exchange for the security of their current savings. Since many retirees don’t want to outlive their retirement savings, they choose investments that are risk-averse.
Key Considerations of Capital Preservation
When selecting assets for a capital preservation portfolio, it’s most important to conform to the investor’s time horizon. Generally, investors who choose capital preservation prefer to focus on market volatility, which is the amount a security or asset fluctuates in value.
Investors who prefer capital preservation methods often select investments, like checking accounts, savings accounts and money market funds insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. These are assets that are immediately available.
If capital preservation is the priority but money will not be needed for a few months, then money market accounts, CDs – both FDIC insured – and short-term Treasury bills are often chosen. The U.S. Treasury also sells Inflation-Protected Securities, which are assets that offer both capital preservation and immunity from inflation.
Finally, assuming money will not be needed for a few years, capital preservation can also be achieved with short-term municipal bonds, short-term corporate bonds, U.S. savings bonds and U.S. agency bonds.
Disadvantages of Capital Preservation
The biggest disadvantage of using a capital preservation strategy is inflation. While fixed-income investments are generally seen as safe and promise foreseeable returns, inflation can wipe out those returns. That’s because the interest rate paid by fixed-income investments is usually a nominal interest rate. This means the rate doesn’t account for inflation. A fixed-income investment’s real interest rate is the nominal rate minus the rate of inflation.
So, if you have a treasury note with a nominal rate of 3% and inflation rises to 2%, the T-note’s real interest rate will be just 1%. Or, perhaps inflation rose to 5%. In this case, your real interest rate would be negative 2%. Essentially, this means that your investment would lose value.
Since inflation can have a big impact on the value of your portfolio, capital preservation is only recommended as a short-term strategy. As a general rule, if you cannot afford to lose any of your retirement savings, it’s acceptable to invest in assets that may yield a 0% or even slightly negative return.
The Bottom Line
The most recommended method of selecting an investment strategy would be to prioritize your time horizon and risk tolerance. If the idea of losing any of your retirement savings scares you, you may want to use a capital preservation strategy. On the other hand, if you believe in trying to reach the highest return possible, even if it means you could lose money, you may want to consider a more risky investment method.
Keep in mind, that your risk tolerance may change over time. It’s okay to select a more risky investment mix while you save for retirement. Once you are in the final stages of retirement preparation, you can change your asset allocation. Make sure to consult with your financial advisor for guidance and support when selecting your investment mix. Your financial advisor can help you choose the best asset mix that matches your goals and time horizon.
- Gauging the advisability of a capital appreciation strategy for your portfolio may be best done with the help of a financial advisor. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to find a local advisor that will help you achieve your financial goals, get started now.
- When it comes to investing, risk tolerance is just one factor. You should also consider how long your investments will have to grow. If you’re in a position where you can invest, you should start as soon as possible. Many people invest for their future, and this retirement calculator can show you why it’s best to invest early and often to achieve your ideal retirement lifestyle.
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