It seems that since the financial meltdown of 2008, everyone believes that their primary objective is Preservation of Capital, and considering some of the returns from 2008, who can blame them. However, the problem I find today is that if you ask 5 different people how they define preservation of capital, you most likely are going to get 4 to 5 different answers. Some think preservation of capital is as simple as protecting what you have now from loss of value. Others believe its simply avoiding any level of risk with investable funds. You will also find many that believe preserving capital is a matter of protecting the purchasing power of your money in respect to the stated inflation rate. Is any one of those answers wrong? I don’t think so; however, we have to have some basis in order to manage funds.
I believe managing capital preservation is being tasked with protecting what one has built over time. Whether it is a fact or not, each person that invests in Capital Preservation is viewed by me as if that was every last investable cent they have. It would be simple to say for maximum safety to put these funds in cash or money market and maybe mix in some US Treasuries for yield. Unfortunately, that does nothing to protect one’s purchasing power of the asset. So how does one actively manage a preservation of capital portfolio, while at the same time protecting against that perceived loss of purchasing power? Simple answer is, provide balance within the framework of your expectations using a combination of Cash, Equities and Tangible assets.
Cash! In reality, there is not a better nominal protector of capital than cash. Let’s face the facts, in the U.S., residents evaluate their wealth in U.S. Dollars. Therefore, cash is the true Preservation of Capital, and should always make up a significant portion of the overall portfolio.
Equities! Value is always what Preservation managers point to for stock selection, but that doesn’t always work out. Just ask some of those managers that started buying bank stocks in mid-2008 based on value. Someone interested in looking for equities for preservation of capital would want to look for equities with strong balance sheets, above average return on investments, solid dividend payouts along with a history of dividend growth and a catalyst that management has identified to protect shareholder value going forward. And an investor should not be constrained to specific sectors. Sectors should not be a limitation so long as it fits your criteria.
Tangible Assets! Precious metals bullion and mining companies make up the volatility portion of the portfolio. For all of the things that are discussed on Financial Sense, scarcity of tangible assets in the years to come is a theme I believe in. The intent of this portion of the account would be to protect the purchasing power of the asset. It provides the balance for the cash held.
In summary, the approach to capital preservation is to protect what you have accumulated over the years and not taking unwarranted risks. Finding a balance amongst asset classes in today’s economic environment is what you want to accomplish with this investment objective. Capital Preservation is not meant for speculating in any one asset class. Some parts of the portfolio should grow when the time is to grow, and other parts will be there to protect when opportunity for growth is not available. Eliminating the large drawdowns in a portfolio is paramount to preserving one’s capital.
About Scott Middleton
Scott Middleton Archive
|01/27/2011||A Tale of Two||story|
|12/23/2010||Year End Housekeeping||story|
|12/09/2010||Acceptance of Reality||story|
|11/04/2010||Thank You Ben…||story|
|10/28/2010||Driven to Export||story|
|10/21/2010||Inflation? What Inflation…||story|
|10/14/2010||Preserving Capital (continued)||story|