Definition
Preservation of capital is a conservative investment strategy aimed at preventing any loss to the original amount (or principal) invested. It prioritizes security of the initial investment, typically by putting money in low-risk or risk-free investments. This strategy is most common among risk-averse investors, retirees, or individuals who are primarily seeking to maintain their current wealth rather than increase it.
Key Takeaways
- Preservation of Capital refers to a conservative investment strategy aimed primarily at preventing potential losses, rather than generating high profits. It prioritizes maintaining the original capital investment and avoids investments that may involve significant risks.
- This investment strategy is particularly suitable for risk-averse investors and retirement funds where the priority is preserving the initially invested capital over a long period. The idea is to ensure that, at the very least, the investor does not end up with less money than they started with.
- Preservation of Capital often involves investing in low risk, and thus typically low return, assets or securities such as Treasury bonds, certificate of deposits or money market funds. While this could mean lower profits, it primarily ensures that the capital remains safe and secure.
Importance
The finance term “Preservation of Capital” is crucial because it relates to strategies implemented to avoid loss in an investment portfolio.
Capital preservation prioritizes safeguarding the original amount of investment over seeking potential returns.
Thus, it is particularly significant for investors with low-risk tolerance or shorter investment horizons, like retirees or those with short-term financial goals.
With capital preservation, the emphasis is on maintaining financial stability and liquidity rather than generating high returns, which can expose the capital to a higher risk of decline.
Despite the potential for lower yields, capital preservation makes it less likely for investors to experience dramatic losses, offering a sense of financial security.
Explanation
The preservation of capital is an investment strategy main objective is to prevent any loss in the initial amount of the investment or the nominal principal. This strategy is typically popular among investors who prioritize safekeeping their initial investment over achieving high returns, serving a cautious role in a broader portfolio.
With this approach, the investor primarily focuses on capital conservation, hence the investments are usually directed towards very low to zero-risk assets that provide consistent, albeit small returns. The main purpose of preservation of capital is to mitigate risk and ensure the primary investment amount remains intact.
This strategy is often employed by conservative investors such as retirees who depend upon the income from their investments for living, as they cannot afford a significant loss in their investment pot. Its also use in institutional investment funds to keep their capital safe while focusing their risk-taking on a smaller portion of their portfolio.
Understanding and using the concept of preservation of capital means balancing this safety-first approach with the potential for asset growth and higher returns.
Examples of Preservation of Capital
Retirement Savings: One real-world example of the preservation of capital is a retiree who prioritizes the preservation of his retirement savings. To achieve this, he might choose to invest in low-risk assets such as bonds and certificates of deposit (CDs) that provide fixed income over the long term and have less potential for loss than riskier investments like stocks.
Real Estate Investment: Another example could be a real estate investor who buys properties in stable markets to minimize the chance of a decrease in property values. By carefully managing his property (routine upkeep, prompt addressing of tenants’ concerns, ensuring full occupancy), the capital invested in the investment property is preserved.
Treasury Bonds: Treasury bonds issued by the U.S government represent a good example of preservation of capital. These bonds are considered nearly risk-free because they are backed by the full faith and credit of the U.S. government. As such, individuals or institutions investing in these bonds are essentially preserving their capital, while also earning a small return. This is particularly relevant for large institutional investors like pension funds or insurance companies, which hold large amounts of capital and seek to preserve it while also earning a return.
FAQs for Preservation of Capital
What does Preservation of Capital mean?
Preservation of Capital refers to an investment strategy aimed at preventing any loss in the original amount of an investment, or the principal amount. The goal here is not to make significant profits, but to prevent or minimize loss.
Why is Preservation of Capital important?
Preservation of Capital is particularly important for risk-averse individuals, like retirees, who cannot afford to lose their principal amount. It provides stability and reduces the financial risk.
What are some common strategies for Preservation of Capital?
Common strategies for Preservation of Capital include investing in fixed income securities like bonds, or money market accounts, using hedging strategies, and diversification of portfolio.
What is the downside of this strategy?
While Preservation of Capital helps in minimizing losses, it also means that the investor may miss out on opportunities for higher returns. The returns on these investments are often lower compared to riskier alternatives.
Related Entrepreneurship Terms
- Risk Management
- Investment Diversification
- Asset Allocation
- Fixed Income Securities
- Capital Growth Strategies
Sources for More Information
- Investopedia: This is a comprehensive financial education website that offers definitions and explanations for all finance and investment terms including preservation of capital.
- The Balance: It is an online resource offering expert advice on personal finance and money management. They have articles covering a wide range of financial topics including capital preservation.
- The Motley Fool: This site provides actions for investing wisdom and guidance. They have a rich resource of articles on topics such as preservation of capital.
- CNBC: This is a leading source for business and financial news. The website also includes a market data section and personal finance section where one may find information about preservation of capital.
