The Myth of Capital Preservation and Growth
Are you interested in growing your investments while preserving capital and avoiding market volatility? Of course! Some investment professionals make this pitch: “Grow your investments safely with no risk!” Or “Beat the stock market with no downside!” These seem appealing. After all, everyone wants to see their investments grow while taking little or no risk. But that’s a little like a “no calorie pizza.” It’s not possible!
Here’s why. Consider the two fundamental characteristics of any investment: risk and return. Modern finance theory dictates the more return you hope to achieve, the greater risk you must take to achieve that return. Higher long-term returns are the reward you get for accepting greater investment risk or volatility. If you are not willing to accept much (or any) volatility (risk) then you must accept lower (or no) growth as well. It’s a tradeoff, even though marketing pitches for “growth and capital preservation” strategies would have you think otherwise. Such strategies may be riskier than a real capital preservation strategy or they may sacrifice almost all potential growth in order to minimize risk—hardly the best of both worlds.
So, what does a real capital preservation strategy look like in practice? It often means investing in cash or cash-like investments: A savings account, certificate of deposit, money market fund or money market account. Buying US Treasurys and holding until maturity can also be a capital preservation strategy. All of these investments have low risk, but low return potential as well. These features can make a capital preservation strategy appropriate for shorter-term investment goals. For example, you might keep money for short-term living expenses in cash, or funds for a house down payment in a lower risk, cash-like investment. In cases like these, the most important thing is to avoid short-term losses. Asset classes with higher short-term volatility, like stocks, would probably not be appropriate in a capital preservation strategy.
Capital preservation strategies, however, are usually not attractive over the long term. While stocks are typically more volatile over the short term, over longer periods stocks offer much higher average annual returns. So, the longer your time horizon the more appealing stocks likely are. Stocks’ short-term volatility comes with the reward of higher long term growth, which can make them more appropriate than a capital preservation strategy for those whose long-term investment goals require growth.
Consider that the S&P 500 has an average annualized return of almost 10% from 1926 to 2018, and has had positive returns in over 70% of those individual years.[i] That means on average, there was a return above and beyond the original investment on a yearly basis. Some of those years were up more than others, and certainly some of those individual years did end at a loss. But market volatility in the near term is minor compared to the positive long-term gains. The average annual return of almost 10% includes bear markets and other downturns. There is no guarantee of returns when investing, but if you can endure stock market volatility, you may be able to capture long-term growth to help you meet your long-term investment goals.
Inflation is another reason capital preservation is not typically a successful long-term strategy. Inflation decreases purchasing power and over a decade or two the effects of inflation can be dramatic. Most capital preservation strategies aren’t likely to outpace inflation. If inflation is 3 percent a year, a dollar today will be worth only about half that in 20 years. This means your money could meet your needs today, but might not in the future. You may need the long-term growth associated with equities in order to ensure your purchasing power keeps up with inflation.
If an investor, company, or individual tells you they can offer capital preservation and growth at the same time, be wary. It sounds great, but is not possible in reality. You should examine your own needs, over the near term and long term, to determine how much capital preservation you may need, and how much growth you may need. If you’re still considering a capital preservation strategy, carefully consider your long-term investment goals. Many investors realize they do want portfolio growth and therefore must accept some risk—like those associated with owning stocks. Volatility risk is only one form of risk among many that you may encounter on your investing journey. Consider your situation and look beyond short-term risk to evaluate what strategy has the best chance of long-term success. Many investors, especially those investing for retirement, need to plan for twenty, thirty or more years. Over such long periods of time capital preservation can be a riskier strategy than investing for growth and being patient and disciplined.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[i] Source: Global Financial Data, as of 05/02/2019. S&P 500 Total Return Index from 12/31/1925 – 12/31/2018.