Capital Preservation Strategy: What to Know

Building wealth is an important goal many have, paving the way for financial freedom and security. Upon retirement age, however, it’s common to shift to a capital preservation strategy to keep what you’ve accumulated throughout your career.

In this article, we’ll explore the essentials of capital preservation, including the types of investments that are typically best suited for safeguarding assets. You’ll also discover who this strategy is ideal for, its advantages and disadvantages, and how a financial advisor can help you determine when to transition into this phase and how to implement it effectively.

What Is the Capital Preservation Strategy?

The capital preservation strategy is an investment approach that aims to prevent losses and protect an investor’s principal. Typically, an investor accomplishes this by purchasing short-term securities that produce modest gains, such as money market funds, treasury bills, or certificates of deposit (CDs). Often, people adopt this strategy when they have reason to avoid risk, such as when nearing retirement.

Shifting to a preservation approach contrasts heavily with the growth strategy you may already be accustomed to. Justin Haywood, CFP^®, president and co-founder at Haywood Wealth Management, explains that, when it comes to preservation, the “goal is not necessarily to grow wealth aggressively but to ensure that the original investment remains intact.” By doing so, you ensure you can reach any impending goals and maintain a sense of financial security.

Types of Capital Preservation Securities

Preserving wealth typically involves creating an asset allocation around short-term, low-risk investments. This allows you to earn modest returns while shielding your funds from the risk level that may come with growth securities. Below are asset classes that may be conducive to capital preservation:

• Treasury bills. These are short-term notes that are backed by the full faith and credit of the U.S. government. After four weeks to one year, they mature, enabling you to cash them in for a profit.
• Money market funds. These are mutual funds that buy, hold, and sell short-term securities. Investing in them allows you to earn both regular interest and capital gains when you sell shares for a profit. They’re also highly liquid, allowing you to convert shares to cash quickly.
• Certificates of deposit (CDs). CDs are short-term investments that produce interest at a fixed rate. The tradeoff, however, is that you must commit to setting your cash aside for a certain period, which can range from a few months to several years.
• High-yield savings accounts (HYSAs). A simple way to preserve cash is to keep it in a HYSA or money market account (not to be confused with a money market fund). These savings accounts allow you to set your money aside at a higher interest rate than typical banks. Additionally, they’re typically insured up to $250,000 by the FDIC.
• Short-term bonds. Bonds that mature over a short period let you shield yourself from risk while earning small returns.

But what if you still want to include growth equities in your portfolio? In this case, Haywood explains that “a small allocation to growth equities can still be part of a capital preservation strategy,” but this depends on “the individual’s risk tolerance and financial goals.” He continues, “Absolute capital preservation strategies may exclude equities altogether, but many people still like to maintain a small percentage to combat inflation and potentially enhance long-term returns.” Still, if you add them to your portfolio while your goal is to avoid risk, the amount should be “modest,” says Haywood.

Who Is the Strategy Ideal For?

The capital preservation strategy has a defined objective—shield your wealth from as much risk as possible. Because of the approach’s conservative nature, it’s typically ideal for a select type of investor. This includes those who are nearing an important financial goal, such as retirement, or who have another need to hold on to their wealth.

One of the key decision-making factors in investing is your time horizon. That is, how much do you have to reach a specific goal?  When individuals don’t have several years or decades to achieve their goal, they may want to shift to a strategy more conducive to longevity and maintaining their portfolio’s value. For example, if you’re 58 years old and plan to retire in four to five years, a financial advisor may recommend that you begin shifting away from growth-minded investments that may present too much risk.

Tom Buckingham, Chief Growth Officer at Nassau Financial Group, points out that a capital preservation portfolio strategy “is likely more palatable as consumers accumulate more assets.” Without “sufficient assets, many will need to take some market risk in order to increase the likelihood of higher gains on their investments,” he says. This makes the approach ideal for those in later stages of life, such as at retirement age, or individuals looking to preserve their capital for estate planning purposes, for instance.

Pros and Cons of the Capital Preservation Strategy

By allocating your portfolio to preserve your capital, you could see several benefits. First, it shields you from risk because you’ll be invested in securities that don’t tend to fluctuate in value, such as short-term bonds, treasury bills, or money market funds. The strategy is also highly predictable because returns are often from set interest rates or fixed income. Finally, by avoiding risk and bringing more predictability into your portfolio, you gain valuable peace of mind that your progress toward your goals won’t be derailed by unnecessary losses.

There are, however, a few downsides to consider before you decide to shift your portfolio strategy. By adopting a preservation approach, you trade off the ability to realize much growth. Moreover, inflation is another risk to be aware of. “If your returns don’t keep pace with inflation, you risk losing purchasing power over time,” says Haywood.

Inflation Is a Major Consideration

One of the external forces that may impact your portfolio is inflation. Shifting a large portion of your portfolio to short-term investments, such as cash or money market funds, can expose you to the effects of rising costs of goods and services. As prices increase, your purchasing power can decline.

For this reason, it may also be wise to invest a portion of your portfolio in securities that can curb inflation, such as treasury inflation-protected securities (TIPS). However, we recommend speaking with a financial advisor to ensure your returns keep pace with rising costs.

How a Financial Advisor Can Help

Shifting your entire portfolio strategy can be a tough task, even for a seasoned investor. At times, it can be crucial to have a financial advisor to help you make the right decisions and structure your portfolio optimally. This includes selecting securities that keep pace with inflation and shield you from risk.

A financial professional can also help you decide whether the capital preservation strategy is right for you. They’ll likely ask you about your goals, time horizon, and risk tolerance to determine what asset allocation your portfolio should consist of. Then, either on a discretionary or non-discretionary basis, they can help you build it to your needs.

We recommend finding a high-quality fiduciary advisor. It’s important to know that a professional has your best interests in mind, especially if they’re managing your investments directly. To find an advisor near you, consider this free matching tool, which will connect you with someone who aligns with your needs.