As you might have noticed, stock market volatility (mostly to the downside) is wreaking havoc with investment portfolios. As a result there appears to be a rising investment strategy trend toward capital preservation. Considering the fears that a recession sparks, it is not especially surprising that many are looking for safe investments. (Or safer investments; no investment is completely safe.) Rather than risk loss, preserving capital becomes an object for those with low risk tolerance — be it financial risk tolerance or emotional risk tolerance. Additionally, for those concerned about impending retirement, an asset allocation strategy with an increased (but not complete) stress on capital preservation is often advised.
Capital preservation is just what it sounds like: You make safe investments in order to prevent loss of your original, principal investment. The return when employing such an investment strategy is usually fairly low, but you do enjoy some appreciation in nearly all cases. Capital preservation stands in contrast to a capital growth investment strategy, by which you attempt to aggressively increase your earnings. While the potential earnings are greater, the risk of loss is also greater — which is why, in this time of turmoil, few casual investors are thinking about capital growth and are instead choosing the preservation route.
Safe investments as part of a capital preservation investment strategy
If your main concern centers mainly around limiting your losses and saving what cash you have, capital preservation may provide you with peace of mind. Here are some of the more popular places that people choose for the purpose of conserving their cash in safe investments:
- Bonds. Bonds — especially U.S. federal bonds — are popular in times of economic turmoil. This is because U.S. debt, with its backing by the most stable tax paying base in the world, is considered one of the safe investments. Bonds have been growing in popularity as investors choose them as a protection from loss of their principal. Additionally, with the expected expenditures coming as a result of economic stimulus efforts, more debt will soon be available for investment purposes. Diversified bond funds are seeing a rise in popularity, since they offer better returns than a cash account.
- Money market accounts. These interest-bearing bank accounts (and even funds) pay interest according to the current market rate. One of the nice things about money market bank accounts is that they are fairly liquid, and you have easy access to the funds in the event of an emergency.
- CDs. Certificates of deposit offer another capital preservation option. Setting up a CD ladder can help you in terms of access to your money, as well as work as an investment strategy for effectively increasing your yield in this particular setting.
The main downside to a capital preservation investment strategy is that the returns are so low. While inflation is not a huge problem right now, it could become an issue in the future once the government starts injecting more cash into the market. Inflation can easily overcome low-yielding investments, even effectively eating away at the value of your capital. So, long-term, even a capital preservation strategy may not actually completely preserve the value of your cash.
Subscribing to a capital preservation style only can be harmful in the long run; you may not have enough cash to see you through retirement. Mixing in a few well-chosen stocks, ETFs or other less safe investments with higher returns can be a good idea, especially since there are so many good bargains to be had.