How Capital Preservation Works and Who Can Benefit | HelpAdvisor.com (2024)

Christian Worstell | July 11, 2023

Investment strategies can vary widely depending on your life stage, the amount of your investable assets and an assortment of other factors. For individuals who are nearing retirement age and want to safeguard their portfolios, one common strategy is capital preservation, which places funds in low-risk, short-term investment vehicles.

Let’s take a closer look at the goals of capital preservation and who may benefit from this type of investment strategy.

What Constitutes a Capital Preservation Strategy?

Capital preservation strategies are designed to minimize risk and prevent loss in an investor’s portfolio, preserving the capital it contains.

This conservative investment strategy, which is sometimes referred to as preservation of capital, typically revolves around stable, short-term investments, and is not intended to be used when growing a portfolio. It’s often preferred by investors who are nearing retirement and other individuals with a low tolerance for risk.

Types of Capital Preservation Assets

Although the goal of capital preservation is to minimize risk to a portfolio and to preserve the capital it contains, regardless of any economic downturns that may occur, the ideal assets may vary depending on your financial goals and personal risk tolerance. The following types of investments may be part of a capital preservation strategy:

• Treasury bonds, notes and bills: These government-issued securities have varying maturity dates, so options are available for investors with different financial goals. Plus, because they pay out at more than the purchase price, they’re a safe investment option.
• Municipal bonds: These securities are issued by government entities such as states, cities and counties to help them fund day-to-day operations or special projects. Munis typically accrue interest semiannually and promise a return on the original investment, making them an ideal addition to a capital preservation strategy.
• S. savings bonds: Because Series EE savings bonds earn interest at a fixed rate for 30 years, they’re a solid choice for capital preservation. They may be cashed in at any time after they've been owned for a year, so they’ll work even as a short-term investment.
• High-yield savings accounts: High-yield savings accounts pay higher interest rates than their standard counterparts, and many don't charge monthly fees, even if you don’t maintain a minimum balance. Although a high-yield savings account won’t grow your portfolio substantially, it's a stable means of preserving capital.
• Certificates of deposit (CDs): CDs often earn a higher interest rate than other types of bank accounts. When money is invested in a CD, it must remain in the account untouched for a predetermined period of time. Although CDs generally offer lower interest rates than stocks and bonds, they aren’t subject to market volatility, making them a good choice for a capital preservation strategy.
• Target-date funds: These mutual funds are designed to optimize asset growth for a designated timeframe to address an investor's financial needs at some future date. Because of this, they’re often used by investors who are nearing retirement.
• Fixed annuities: Fixed annuities, which are classified as insurance, are often used in retirement planning and capital preservation because they guarantee a specific interest rate. An intermediate fixed annuity may start paying out within a year of signing the contract.

Who Should Consider a Capital Preservation Strategy?

A capital preservation strategy is typically used by investors who have a short timeframe for investing and can’t risk losing their assets to market volatility. If you’re nearing retirement age, you may want to consider a capital preservation strategy to safeguard your assets rather than using high-risk strategies to continue to grow your portfolio.

A capital preservation strategy may also suit younger investors who'll need to access their assets in the next three to seven years for expenses such as the down payment on a house or a child’s college education.

Are Capital Preservation Funds Safe?

Generally, capital preservation funds are chosen because they’re considered safe, short-term investments. Plus, many of these accounts are insured for up to $250,000 by the Federal Deposit Insurance Commission (FDIC) in the event that funds are missing due to robbery, embezzlement, fires and other unexpected occurrences.

Occasionally, however, investors may be lured by new securities. Although these new securities may be advertised as safe, short-term investments, many are unproven in times of economic downturns and may not be as safe as they claim. To ensure the safety of your capital preservation funds, it’s generally better to stick with familiar investment vehicles such as CDs and savings bonds.

Does Capital Preservation Have Drawbacks?

Although a capital preservation strategy may provide peace of mind for investors who need to keep their assets protected, it does have several drawbacks:

• Lower interest rates: Capital preservation isn’t designed for growth. Typically, assets used for asset preservation pay less than 2% interest as opposed to stocks and other higher-volatility assets, which can bring in an interest rate of more than 7%.
• Inflation: Inflation may erode the value of an investment over time. Although the dollar amount in your portfolio is preserved, inflation can reduce the purchasing power so that, in practical terms, your portfolio loses value.
• The lure of new securities: Investors may be lured by new, unproven securities, which can turn out to be unstable if an economic downturn occurs costing investors money.

What's the Difference Between Capital Appreciation and Capital Preservation?

Capital preservation refers to a conservative investment strategy that aims to protect assets in a portfolio through investments in stable, short-term vehicles.

Capital appreciation refers to an increase in the market price of an investment product. Essentially, capital appreciation is the difference between the amount you paid for an investment and the amount you sold it for. The term is typically used in connection with the following investments:

• Stocks
• Commodities
• Mutual funds
• Real estate
• Exchange-traded funds

Should I Invest for Growth or Preservation?

Deciding whether to invest for growth or preservation depends on your financial goals and your investment timeline. Although there may be some exceptions, younger investors, who have time to ride out market fluctuations, should typically invest for growth, while investors nearing retirement may want to consider a preservation strategy to ensure the safety of their assets.

Before investing, you may find it beneficial to consult a financial advisor, who can help you assess your current financial health and set realistic investment goals. If you’re retiring soon and need to protect your portfolio from loss, a knowledgeable financial advisor can also help you choose low-risk investments that are appropriate for your personal timeline.