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Preservation of Capital

Updated on March 20, 2024
Article byHimani Bhatt
Edited byHimani Bhatt
Reviewed byDheeraj Vaidya, CFA, FRM

Preservation of Capital Meaning

Preservation of capital is a conservative investment approach intended to protect money and avoid losing value in a portfolio. It ensures retaining the monetary value of an asset. This entails investment in secure and temporary instruments like treasury bills, savings accounts, and certificates of deposits (CDs). 

Inclusion of assets into the capital preservation portfolio relies upon the investor’s risk tolerance level and financial targets. Usually, investors with low-risk tolerance and short time horizons like pensioners employ this method. As a result, capital preservation brings smaller returns than other strategies that offer a higher return and more fierce growth.

What is capital preservation

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Key Takeaways

  • Preservation of capital saves the current principal amount and maintains its value in the portfolio through investment in low-risk instruments. 
  • The limitations of capital preservation include inflation, inaccessibility of secure investments, and negligible returns. 
  • The low-risk investments encompass savings bonds, high yield savings accounts, government notes, bills, bonds, and certificates of deposit. 
  • Old-age retirees or young investors with housing mortgages commonly choose this investment approach. 
  • Its main objective is to retain the value of the available capital without the desire to earn high yields.

Preservation of Capital Explained

Preservation of capital typically helps in safeguarding the investor’s funds via investment in short-term and safe instruments. Here, the main objective is to secure and maintain the principal amount without an appetite for massive prospective gains. Thus, asset protection and its long-term durability shape the investment decision.

A capital preservation portfolio holds securities that are needed in the following 2-6 years. This includes treasury bills, high-yield savings accounts, US savings bonds, municipal bonds, target-date funds, CDs, and Annuities (Fixed and Immediate). It shields investors with a set remuneration from market arbitrariness.

Preservation of capital and income generation is crucial for aged investors. Unlike younger investors with enough disposable time, market inconstancy is a huge danger for the senior group because of instant capital requirements. As a result, they have a shorter timeframe to recover from loss and increase savings. This is why the capital preservation strategy gives priority to preventing asset losses.

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Who must opt for the preservation of capital?

Capital preservation is perfect for old-age pensioners dependent on reserves and investments to cover current livelihood expenditures. These types of investors also face the problem of a shortened period for recovery from losses. Therefore, it aids them in preserving wealth and supporting their lifestyle after concluding their professional tenure. Also, capital preservation is convenient for youthful investors to save cash for a real estate down payment.

Investors must consider market alterations before selecting securities for capital preservation. In other words, they must be able to secure the capital’s nominal worth, excluding the additional costs. Moreover, doubtful investors may connect with a financial consultant and choose the finest allocation mix befitting their risk tolerance, time horizon, and monetary goals.

Purpose of capital preservation

Investment techniques differ according to the investor’s life stage and risk tolerance. Preservation of capital and income generation secures the asset’s inflation-adjusted earnings. Thus, it ensures that a pile of cash can purchase a similar amount of products within the retention period. In conclusion, capital preservation is crucial to investing.

Stock investments are unsafe for this method due to unexpected market variations. However, bonds with short duration are deemed suitable for the same. This is because it is driven by the idea to safeguard wealth and not gain significant profits. Nevertheless, increased dividends might be the by-product of this process.

Benefits of capital preservation

Here are the major advantages of capital preservation.

  1. Assured money safekeeping for a short period.
  2. Assists retirees sustain a financially sound lifestyle.
  3. At times, it offers minor gains. 
  4. Lowers the risk level to a great extent
  5. Ensures loss prevention

Therefore, the preservation of capital is commonly referred to as a safe investment approach. Federal Deposit Insurance Commission (FDIC) ensures most of these accounts are for at most $250,000 in the event of missing finances due to any sudden happenings.

Examples

Example #1

recent MoneyWeek news report discusses the relevance of capital preservation amid the ongoing Russian invasion. Consequently, the existing inflation problem has become substantially worse and will remain the same for a prolonged period. In addition, this will result in domestic unrest.

So, the focus must be on preserving capital rather than growing the income. Steering clear of dangers with efficient management is suggested rather than identifying opportunities.

Example #2

Another latest article by Medium mentions how capital preservation helps combat high inflation and a low-interest-rate environment. Accordingly, if everything goes right, it helps the investors live off around 10% of their total value and 6-12 months of emergency expenditures. The article also suggests readers invest at least 5%-10% of their assets into a low-risk instrument.

Limitations

#1 – Inflation

Inflation reduces the value of money, thus diminishing the purchasing power. Accordingly, employing this strategy long-term safeguards the investor’s money but provides lower dividends with even a 1% or 2% inflation rate.

However, there are a few alternatives to resolve this issue. For instance, investors with sufficient riches may utilize compounding interest to counterbalance inflation. Also, the US Treasury’s Inflation-Protected securities are a good investment option.

#2 – Unavailability of safe investments

The present-day market environment is unpredictable, with continually shifting financial conditions. So, there are a limited number of risk-free, reliable, and sound investments in the economic landscape.

#3 – Minor profits

Prolonged variability and persistently changing market landscape lessens the probability of positive returns. Hence, such investments provide meager to almost zero revenue.

Frequently Asked Questions (FAQs)

What does the preservation of capital imply in investing?

It is a conservative investment method to secure an asset’s monetary value through investment in low-risk vehicles. Less often, it refers to safeguarding the inflation-adjusted purchasing power of security.

How to preserve the capital amount?

1. Reduce the exposure to adversely performing assets after inflation and aim at equities, real estate, or any such real assets.
2 . Enhance the time horizon.
3 . Avoid short-lived portfolio irregularities owing to market fluctuations and political upheaval.

What are the short-term investments for the preservation of capital?

1. US treasury bills
2. High-yield savings accounts
3. US savings bonds
4. Municipal bonds
5. Target-date funds
6. Certificates of deposits (CDs)
7. Annuities

4. What are the limitations of capital preservation?

The limitations of capital preservation are,
1. Inflation
2. Unavailability of low-risk investment vehicles, and
3. Minor to almost zero dividends

This has been a guide to the preservation of capital and its definition. Here we discuss the purpose, benefits, examples, limitations, & who must opt for it. You may also have a look at the following articles to learn more –

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