Since the dawn of the financial markets, investing has been a sought-after activity for many people who want to build wealth and protect wealth.
You can apply many investment strategies to your portfolio, and it can be very overwhelming to figure out which one you should pick. But, you must remember that there is no one right way to invest.
With that said, if you seek an investment strategy that is safe and protects your capital, then continue reading to know more about the capital preservation strategy.
What is capital preservation?
Preservation of capital is an investment strategy that primarily aims to protect the value of your money and prevent losses in your portfolio. Its main goal is not to create massive gains but rather to avoid market volatility and protect the principal amount.
This is why a capital preservation portfolio holds assets with minimal risk and short time horizons (two to six years). Some examples of these assets are high-yield savings accounts, treasury bills, time deposits, and annuities.
Most capital preservation portfolios do not hold stock investments as they are at risk of being swayed by market instabilities.
Is preservation of capital a good fit for all investors?
Employing the preservation of capital strategy is not for all investors. This investment strategy is more suitable for risk-averse investors with a short time horizon - like retirees or pensioners.
As people grow older, capital preservation becomes more important. They have a shorter time to invest and grow their principal and recover from losses because they will need the money when they retire soon. Their goals, then, mainly shift from growing capital to protecting capital - thus a shift to investing conservatively.
As a result, capital preservation generates smaller returns than other strategies offering higher returns.
Preservation of capital strategy is typically not suitable for young investors who want to maximize capital appreciation. They can be aggressive and take on more risk as they have a longer time horizon that allows them to ride out any market volatility in the short term. Older investors don’t anymore have the luxury to do this.
Growth portfolio vs. Capital preservation
The difference between a growth portfolio and a capital preservation portfolio lies in their investment purpose and affinity to risk.
A growth investment strategy aims to grow capital and generate returns quickly. Therefore, growth investors are willing to take on more risk and invest in assets, mostly stocks, that have high growth potential.
It is not rare for growth portfolios to carry trending stocks or high-yield but riskier bonds. It also has a longer time horizon so that the portfolio has enough time to recoup possible losses or withstand market variations.
This is a complete contrast to the capital preservation strategy that only holds assets with little to no risk at a shorter time horizon as its purpose is mainly to preserve the value of capital.
Disadvantages of capital preservation
Preservation of capital, although has its strengths, also has weaknesses - low profits, and drawbacks against inflation.
Because the goal of capital preservation portfolios is not focused on growth, they have lower returns than other investments.
While high-risk, high-reward assets like stocks can average an annual return of 7 percent or more, assets in capital preservation portfolios usually have a much lower interest rate (as little as 2 percent).
Drawbacks against inflation
Earning a meager return for your investments would also mean that your portfolio cannot compete against the rise of inflation.
For example, if your preservation of capital portfolio earns a 2% return per year and inflation is at 3%, then that means your portfolio is still decreasing in value. It is not “preserved” per se despite having the same amount of cash as the purchasing power of your capital weakens.
Safe investments, then, in this case, aren’t safe anymore if they lead to a decreasing value for your portfolio. After all, you employ the preservation of capital investment strategy to protect your wealth.
PECM (or PECL) vs. preservation of capital
The opportunity is that it is still possible for you to get the low-risk strength of preservation of capital strategy but with consistent higher returns through PECM.
The Medium Risk Strategy (PECM) or the upcoming low risk one (PECL) allows you to get a higher annual return (around 3%) compared to the preservation of capital strategy with 2% or less while avoiding market volatility and risk. But more importantly, it allows you to preserve your capital without sacrificing portfolio value to inflation through its consistent and steady growth.
PECM, in this case, can be a capital preservation portfolio without the drawbacks of one.
Stability over risks
Capital preservation is one of the most popular strategies because of its stability. If it doesn’t suit your needs, keep in mind that there are still many financial products that might be more compatible with you. You just have to keep an open mind.