Capital preservation is a term used in the investment industry to describe certain specific financial goals. Preservation involves protecting the monetary value of assets.
What is Capital Preservation?
Capital preservation refers to the fact that certain funds are not meant for larger growth. If that occurs, it is the icing on the cake, but it is not the reason you set it aside. It is not the reason for its existence.
Instead, these funds are saved just to be available when you need them. At some point, you plan to spend the money. Often, this is necessary because you are nearing retirement or currently enjoying retirement. You will use the funds to pay your bills, cover your medical prescriptions, keep warm in winter, and go out to dinner occasionally. However, for younger investors, the funds are usually allocated for a down payment on real estate.
How Does Capital Preservation Work?
The reason it is essential to define a capital preservation goal is that the preservation process will severely restrict the investments that are considered a suitable place to put your money.
Practical experience shows that a variety of high-value stocks, held in a tax-efficient and low-cost manner, will typically outperform all other asset classes. This outcome assumes you have enough time and that the initial purchase price was reasonable and not overvalued.
However, stocks are not suitable for someone with a capital preservation goal. This occurs because these securities can experience fluctuations in value. Similarly, bonds are often considered safe for preservation purposes. However, if you introduce a long maturity period for bonds, you may see value fluctuations that are significant, if not greater, than the stock market.
Main Considerations for Capital Preservation
The main consideration when choosing assets for capital preservation is volatility. Volatility is the amount that securities or accounts fluctuate in value. This value is expressed as a percentage of the original cost value.
Classic options for capital preservation in the United States include FDIC-insured checking accounts, savings accounts, money market accounts (not money market funds – those are different), and certificates of deposit (CDs). You might also add very short-term treasury bonds – placed directly with the U.S. Treasury through a TreasuryDirect account – to this category.
In all cases, the investor should be able to maintain the nominal value of their money, minus any fees or banking expenses.
Other options include having actual bills stuffed under a mattress, in a coffee can buried in the backyard, or placed in a safe deposit box, although all of these options come with their risks.
Note: U.S. savings bonds can be a good option for an investor with a slightly longer time horizon and no current need for cash income.
Choosing the Right Assets
New securities come to the forefront on Wall Street almost once every generation, and people use them as if they were equivalent to cash in their capital preservation needs. Then, a recession or another crisis inevitably occurs, and it becomes very clear that the security was an illusion.
This happened during the Great Recession of 2008 and 2009 with something called variable price securities. People treated these investments as if they were identical to cash in a bank. They were not, and some people lost millions of dollars almost instantly when they could not find a buyer for their securities.
As a rule
In general, it is useful to remember that if capital preservation is truly essential, it is better to accept a 0% return rate or a slightly negative return rate after inflation, rather than putting money that you cannot afford to lose at risk.
Key Takeaways
Capital preservation means keeping your money in low or no-risk vehicles so that you do not lose your money. Stocks are not considered suitable for capital preservation due to volatility in value. Volatility is an important consideration when deciding on the appropriate vehicle to use for capital preservation. Be wary of new securities that seem to promise safety. Instead, look at established options like carefully selected bonds, savings accounts, certificates of deposit, money market accounts, and short-term Treasury bonds.
Was this article helpful?
Thank you for your feedback!
Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and keep our content accurate, reliable, and trustworthy.
Was this article helpful?
Thank you for your feedback!
Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and keep our content accurate, reliable, and trustworthy.
Was this article helpful?
Thank you for your feedback!
Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and keep our content accurate, reliable, and trustworthy.
Was this article helpful?
Thank you for your feedback!
Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and keep our content accurate, reliable, and trustworthy.
Source: https://www.thebalancemoney.com/what-is-capital-preservation-357163
.lwrp .lwrp-list-row-container{
display: flex;
justify-content: space-between;
}
.lwrp .lwrp-list-row-container .lwrp-list-item{
width: calc(12% – 20px);
}
.lwrp .lwrp-list-item:not(.lwrp-no-posts-message-item){
}
.lwrp .lwrp-list-item img{
max-width: 100%;
height: auto;
object-fit: cover;
aspect-ratio: 1 / 1;
}
.lwrp .lwrp-list-item.lwrp-empty-list-item{
background: initial !important;
}
.lwrp .lwrp-list-item .lwrp-list-link .lwrp-list-link-title-text,
.lwrp .lwrp-list-item .lwrp-list-no-posts-message{
}@media screen and (max-width: 480px) {
.lwrp.link-whisper-related-posts{
}
.lwrp .lwrp-title{
}.lwrp .lwrp-description{
}
.lwrp .lwrp-list-multi-container{
flex-direction: column;
}
.lwrp .lwrp-list-multi-container ul.lwrp-list{
margin-top: 0px;
margin-bottom: 0px;
padding-top: 0px;
padding-bottom: 0px;
}
.lwrp .lwrp-list-double,
.lwrp .lwrp-list-triple{
width: 100%;
}
.lwrp .lwrp-list-row-container{
justify-content: initial;
flex-direction: column;
}
.lwrp .lwrp-list-row-container .lwrp-list-item{
width: 100%;
}
.lwrp .lwrp-list-item:not(.lwrp-no-posts-message-item){
}
.lwrp .lwrp-list-item .lwrp-list-link .lwrp-list-link-title-text,
.lwrp .lwrp-list-item .lwrp-list-no-posts-message{
};
}
Leave a Reply