What Is Capital Preservation?
Capital preservation is a financial strategy focused on safeguarding your money. The goal of capital preservation is more about preserving your capital — hence the name — and less about growth.
Financial advisors often grant a green light to younger people to take a more aggressive approach with their money and take on some risk. But as we age, the window to grow investments and rebound from losses gets smaller, so a more conservative approach can be wise at a later stage in life.
Capital preservation sacrifices large potential returns in exchange for stability and security and is typically deployed in the short-term, such as for assets that may be needed within the next 10 years or less.
Where can I invest in capital preservation?
Some examples of capital preservation include:
Traditional savings accounts only earn around 0.05% interest per year, but some high-yield savings accounts can earn up to 1% per year and offer a safe way to boost your interest earnings.
A certificate of deposit (CD) provides an interest rate premium in exchange for leaving the lump-sum deposit for a predetermined length of time.
U.S. savings and municipal bonds
A bond is a loan to the government that generates interest identical to a high-yield savings account and are backed by the U.S. government.
Treasury bills are short-term government securities with maturities ranging from just a few days up to one year and are sold at a discount from their face value.
An annuity is a contract issued and distributed by financial institutions where the funds are invested with the goal of paying out a fixed income stream later on.
Target rate funds help to manage risk by gradually reducing risk as the predetermined target date nears.
All of these methods of capital preservation have interest rates of no more than around 3%.
What is capital preservation vs. income?
Income generation is for those who want to produce a growing income from their initial investment. An example would be shares of stock in large corporations that pay dividends. Most people who make these types of investments are retired and use the income for living expenses.
Capital preservation is at the opposite end of the spectrum. These types of investments won’t garner much income, but also don’t come with the risk or volatility of the stock market or other income-generating investments.
When is capital preservation a smart strategy?
Capital preservation is a good idea when approaching retirement age in order to safeguard your funds and support your lifestyle after you stop working or to fund health care costs in retirement.
Capital preservation may also be used by younger people who wish to gradually save up money for a home, wedding, or other large expense.
What are the drawbacks of capital preservation?
The main drawback of capital preservation is inflation. The interest earned on most capital preservation verticals is often less than 3%, and even modest inflation can grow at up to 2%. It’s possible that any gains made by a capital preservation strategy can be nullified by inflation, and the chances of that scenario only increase over time. That’s why capital preservation is best used only in the short term.
How do I get started with capital preservation?
The capital preservation verticals outlined above are available at most major banks and investment companies. Talk to a licensed financial advisor to learn about the savings and investment options available that can best fit your needs and goals.