Capital Preservation
An investment strategy involving preserving capital and avoiding loss of value
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What is Capital Preservation?
Capital preservation is an investment strategy that promotes saving, i.e., preserving capital and avoiding loss of value. The strategy adopts a conservative approach towards investing specifically in “safe” short-term instruments such as savings accounts, FDIC-insured checking accounts and Treasury bills, and certificates of deposits (CDs).
Key Factors in Capital Preservation
1. Levels of risk and volatility
Investors looking to adopt a capital preservation investment strategy are generally averse to risk, in the sense that they would want to invest in the least risky option. It is because such investors are looking to invest with the sole aim of preserving their capital. They don’t see the potential for their capital to grow in the near future and simply want to retain or preserve the most of it that they can, avoiding any possible loss of value.
2. Safety and stability of investments
Since investors are only looking for investments with minimal risk and the least volatility, the safety of investments and their long-term stability become major determinants in their investment decisions. Hence, they often settle for the safest investment options like insured checking and/or savings accounts, government bonds, money market accounts, Treasury bills, certificates of deposit, and inflation-adjusted accounts. It is because they are some of the safest investments with the highest amount of stability.
Generation of Returns
Capital preservation aims to protect what an investor already owns, i.e., preserve the face value of existing capital. It is a safety net strategy, and hence not all are motivated to generate abundant profits in exchange for bearing risk. The level of returns an investment generates doesn’t really matter as much, as long as it preserves capital and minimizes loss of value.
Capital preservation, as an investment strategy, generates very minimal returns. It seeks to protect an investor from market volatility rather than generate significant profits for them. Hence, it is usually adopted by investors with a fixed income. Also, it is also common among retired individuals who want to preserve what they currently own to cover their living expenses in the future.
Limitations of Capital Preservation
1. Loss of availability
In today’s volatile market conditions and constantly fluctuating economic conditions, the “safety” of all kinds of investment strategies is constantly put in question, and there is some amount of risk associated with each strategy. Hence, in the current dynamic economic world, it is becoming less and less possible to offer capital-preserving investments. Hence, there is an overall loss of availability of safe, stable, and risk-averse capital-preserving investment options.
2. Very few to near-zero returns
It is becoming increasingly difficult for capital preservation investment options to offer a good return, due to the continued uncertainty and constantly fluctuating market conditions. As a result, most investment options are barely able to generate returns. Such investments in today’s market offer only very little to near-zero returns.
3. Inflation
Since certain investments potentially offer very low, near-zero returns, investors are barely able to cope up with the increasing inflation rate arising from today’s dynamic economic conditions. Because capital preservation cannot sustain recent inflation levels, it is not able to fulfill its purpose and fails to preserve the purchasing power of capital.
It is usually because the investment ends up generating negative real returns after the adjustment of inflation rates. Hence, their lack of availability increases and discourages investors even further.
Real-life Example: Government-insured Investment Options
In the current turbulent market times where it is becoming increasingly difficult for investors to preserve their capital, the U.S. government offers insured investment options. Such options are inflation-adjusted in order to avoid the limitations of capital preserving existing today.
From the Federal Deposit Insurance Corporation (FDIC), risk-averse investors can avail of FDIC-insured certificates of deposits, FDIC-insured checking and savings accounts, and even FDIC-insured U.S. Treasury bills. The options serve to limit inflation abuse on specific investment vehicles.
Related Readings
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