What Is Capital Preservation?
Capital preservation is a conservative investment strategy aimed at protecting your money and avoiding loss inside your portfolio. It is often used by retirees or people approaching retirement who have a low risk tolerance and short-time horizon.
What Is the Goal of Capital Preservation?
The objective of capital preservation is to safeguard your money, usually for the short term. Growth is not the primary goal.
As people age, preserving cash and capital becomes more important. Time horizons are shorter, giving investors a smaller window to grow funds and rebound from losses.
Financial experts recommend reducing your risk with age. Market volatility is a bigger threat as you near retirement because you need the money soon — not in 30 years, like a younger investor.
That’s why assets needed within the next three to seven years should be invested conservatively, with a focus on protecting principal.
In short, capital preservation gives up large potential returns in exchange for security and stability.
Types of Capital Preservation Investments
Capital preservation securities are associated with minimal risk.
Some capital preservation investments — including savings accounts, CDs, federal bonds and treasury bills — are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000.
Selecting the right assets to protect your principal and preserve capital depends on your personal risk tolerance and financial goals.
- High-yield savings accounts
- Treasury bills
- Municipal bonds
- U.S. savings bonds
- Certificates of deposits (CDs)
- Target-date funds
Bonds and CDs are low-risk savings tools. Both work by holding money in an account for a specific time. When that time is up, your preserved principal is returned along with some interest.
Interest rates for municipal bonds can average around 3 percent. A one-year CD interest rate averages about 0.64 percent a year.
High-yield savings accounts opened online or through a credit union can earn 0.5 to 1 percent a year. By comparison, a traditional savings account earns about 0.06 percent a year.
Treasury bonds, notes and bills are all backed by the U.S. government. These three options earn interest in slightly different ways and mature at different times.
For example, Treasury notes mature within two to 10 years, while Treasury bonds usually take at least 10 years to mature. Treasury bills have the quickest turnaround, with a maturity of one year or less.
Finally, annuities are an insurance product that can be used for capital preservation. They guarantee an income stream for a certain period and are often tied to current interest rates.
There are many types of annuities, but they can be a complex way to safeguard your money. Make sure to carefully research your options before purchasing one. Immediate and fixed annuities tend to be popular options for principal protection.
Who May Be a Good Fit for Capital Preservation?
Many retirees worry about outliving their savings. Capital preservation is ideal for retirement age people because this demographic relies on investments and savings to cover current living expenses.
Investors who use this strategy tend to be risk-averse and have a short time horizon. Often, retirees or those approaching retirement will use a capital preservation strategy to safeguard funds and support their lifestyle after they stop working.
However, capital preservation can be useful for some younger investors, too.
For example, people in their 20s or 30s may want to practice capital preservation to save money for a down payment on a home.
If you’re not sure if capital preservation is right for you, consider speaking to a financial advisor. These professionals can help you select the best allocation mix to match your goals, risk tolerance and time horizon.
Disadvantages of Capital Preservation
Inflation is the biggest drawback of capital preservation.
Because time erodes the value of money, $100 today will have much less purchasing power in 20 years.
While stocks and similar investments can earn average annual returns of 7 percent or more, capital preservation assets usually rely on much-lower interest rates averaging less than 2 percent.
Your principal is protected, but over time, the interest you earn may not keep pace with an even modest inflation rate of 1 percent to 2 percent.
The longer you employ a capital preservation strategy, the more likely inflation will diminish the value of your securities.
That’s why capital preservation is usually recommended on a short-term basis. Still, some options exist to help hedge against this drawback.
For example, the U.S. Treasury sells Inflation-Protected Securities, or assets that offer capital preservation and inflation adjustments.
Also, if you have enough money saved in your bank account, compounding interest may be able to offset inflation.
6 Cited Research Articles
- USA.gov. (2020, August 11). Saving and Investment Options. Retrieved from https://www.usa.gov/saving-investing
- Friedberg, B. (2020, January 2). How to Invest for Capital Preservation. Retrieved from https://money.usnews.com/investing/portfolio-management/articles/how-to-invest-for-capital-preservation
- Chorpenning, A. (2019, December 17). A Guide to Investing for Capital Preservation. Retrieved from https://finance.yahoo.com/news/guide-investing-capital-preservation-193429083.html
- Isbitts, R. (2019, May 9). Why It's A Great Time For 'Aggressive Capital Preservation.’ Retrieved from https://www.forbes.com/sites/robisbitts2/2019/05/09/why-its-a-great-time-for-aggressive-capital-preservation/#2078ad514978
- Frankel, M. (2018, May 10). Treasury bills, bonds and notes: How are they different? Retrieved from https://www.usatoday.com/story/money/markets/2018/05/10/whats-difference-between-treasury-bills-bonds-notes/33998619/
- Rose, J. (2016, October 18). 7 Strategies To Protect Your Principal From The Next Stock Market Crash. Retrieved from https://www.forbes.com/sites/jrose/2016/10/18/7-strategies-to-protect-your-principal-from-the-next-stock-market-crash/#55ee524969b5