Successful investing is based on earning a positive return on the productive capacity of capital assets. If an investor finds that their capital assets become devalued, the entire purpose of investing is thwarted. To protect against investment assets becoming degraded and losing their value, careful investors use capital preservation techniques. In this article, financial  expert Rory Brown explains the concept of capital preservation and describes assets that are appropriate for capital preservation.

Capital Preservation Defined

The purpose of capital preservation is to protect the cash value of an investment asset. Assets to be preserved are usually measured in nominal cash values, although many investors target an inflation-adjusted absolute value for preservation. The idea is that investors wish to secure the same purchasing power that can be derived from an investment asset as a failsafe value in the event of circumstances that can damage overall asset values. When an investor is confident that appropriate capital preservation steps have been taken, they turn their attention to management strategies that will result in returns and actual earnings on a portfolio of investment assets.

In general, investors use capital preservation to protect the starting (or adjusted) value of assets that are intended as savings vehicles first and foremost, and as income-earning investments only thereafter. Many investors consider the “savings” portion of their portfolio as the assets they wish to primarily preserve. These savings need to be preserved for future spending, whether on retirement, college funds, housing, or other expected expenses. Once those assets have been established, investors look to expand other parts of their portfolio into higher-risk, higher-return investments.

Which Investment Assets Are Well Suited For Capital Preservation

Capital preservation assets are usually chosen in order to avoid volatility. Volatility refers to the likelihood that an asset’s value can see large and rapid changes, either up or down. Traditional assets that emphasize stability over volatility include bank accounts insured by the FDIC, including checking, savings, money market accounts, and certificates of deposit. Short-term treasury bond accounts are also classic capital preservation assets. The key to inflation-adjusted capital preservation is to match the period of time an investor expects to hold an asset with the expected inflation rate over the same period. Long-term assets that earn less than the annual rate of inflation can lose substantial core value over longer holding periods.

Investors also have to watch expenses and taxes related to capital preservation assets closely. For high-income investors, it may be imperative to look at stable tax-free investments like municipal bonds. Depending on how closely the return on an investment tracks overall inflation, recurring expenses can negatively affect asset valuation.

Stocks are not appropriate for capital preservation investments, as the value of even blue-chip stocks can be very volatile under many market conditions. Assets that appear on their face to be secure against large valuation changes can be dangerous if they are dependent on some group of individual borrowers to repay debt. Any investment asset that is dependent on finding a ready buyer to purchase it in order to support its value can become impaired if the market of buyers disappears.

About Rory Brown | Mr. Rory Brown is a Managing Partner of Nicklaus Brown & Co., the Chairman of Goods & Services, Nearshore Technology Company, and a member of the board of directors of Desano. Mr. Brown is also the co-founder of Lydian, which garnered him recognition by Ernst & Young as Financial Service Entrepreneur of the Year. He is passionate about the history of money and how our modern currency has evolved into what it is today.