Why investment schemes offering capital preservation and growth are 'fictional'

Capital preservation means the eradication of any possible volatility. Getty Images

World peace. Calorie-free chocolate cake. Sensible American political candidates.

Another fictional allure is any investment scheme promising equity-like growth and capital preservation.

Yet so many in the investment industry claim otherwise, peddling poor products largely set to deliver disappointment.

Rational goals and expectations are key to successful investing.

Said simply: growth and capital preservation, in their true sense, can’t co-exist in the short run.

However, achieving growth probably means accomplishing both long-term. Confused? Let me explain.

“Capital preservation” sounds appealing … safe. With headlines shouting about interest rates, “sticky” inflation, wars and tense US and European elections, simply securing what you have sounds perfectly prudent.

But a true capital preservation strategy is wise for far fewer people than almost anyone imagines.

Why? True capital preservation means your portfolio’s value should never fall. It is the eradication of any possible volatility.

Sounds nice. But volatility and negativity aren’t synonymous – a 1 per cent rise is similarly volatile to a 1 per cent dip.

In the stock market, volatility is much more often up than down. Eliminate the down and the up disappears also, always.

Consider America’s S&P 500 index for its longest accurate history. Eliminating volatility means you dodge the 62.9 per cent of calendar months US stocks rose (and 73.5 per cent of all years from 1926 to 2023).

Effectively, a true capital preservation strategy is limited to cash or near-cash vehicles. Those deliver ultra-low returns over time. Growth? No. And eaten alive by inflation.

Treasury bonds offer better-than-cash long-term returns today. But they don’t eliminate volatility, as 2022’s stock-like bond swoon proved.

Bond prices and yields move inversely, mechanically, so 2022’s rising rates slaughtered 2022 bond returns.

Even very short-term bonds saw price declines negate almost all the higher interest you earned.

Then comes inflation. It has averaged about 3.5 per cent long term, though it soared the past two years.

As I write, the 10-year Treasury yields 4.33 per cent. The 30-year Treasury delivers 4.49 per cent.

Lock up your funds for 10 or 30 years now, and maybe you come out ahead of inflation (assuming the average holds). And maybe not. But you still have volatility.

If long-term Treasury yields fall back to 2010 levels, even small upticks in consumer prices could erase all the yield – or enough that you won’t get anything resembling actual growth.

Even mild growth requires some volatility. It is the opposite of capital preservation.

Never forget that without downside volatility, there is no upside. Never, ever. Just illusion.

Hence, as unified investing goals, capital preservation and growth can’t co-exist.

If someone tells you otherwise, they are wrong. Maybe they are foolish enough to believe it, which is bad.

Maybe they are hocking awful products – insurance products, “buffered” funds or other – which is worse. Or, worst of all, maybe they are just crooks, who frequently tout “upside with no downside”. Think Bernard Madoff and all Ponzi schemes.

The more growth you need, the more short-term volatility to expect. Full stop.

So if you need equity-like growth, prepare for volatility. If you aren’t able to, expect lower returns, which may require reconsidering your goals.

And, probably, reconsidering your savings and spending rates.

With that out of the way, let’s get to the good news. While capital preservation and growth don’t work as a combined goal, the result of a long-term growth goal is you likely preserve capital over the long term.

While capital preservation and growth don’t work as a combined goal, a result of a long-term growth goal is you likely preserve capital over the long term

Ken Fisher

Consider that in the 79 rolling 20-year periods from 1925 to 2023, US stocks have never been negative. Never. And they average 806 per cent returns. That is big growth.

The past never guarantees the future, but it does tell you if something is reasonable to expect.

Human nature changes too slowly to diminish the power of profit motive in any relevant timeframe. As such, stocks should continue to net superior returns over the longer-term future.

Which means a well-diversified equity portfolio is very likely to grow over the coming two decades – maybe a lot. Maybe it will double, triple or more – despite bouts of gut-wrenching negativity in route.

So, take the long view. If you consider that very realistic investing time horizon, it may look like you achieved big growth while preserving initial capital. But it all stemmed from pursuing growth.

Actually pursuing capital preservation means curbing or capping growth. You may wind up with less after inflation – achieving neither goal.

Anyone hocking growth with capital preservation is peddling the impossible. Don’t pay them any more heed than you would pay to politicians offering free, calorie-free chocolate cake and guarantees of world peace.

Ken Fisher is the founder, executive chairman and co-chief investment officer of Fisher Investments, a global investment adviser with $250 billion of assets under management