Which Investments Might Be Best for a Capital Preservation Portfolio?
Examples of the Types of Assets That Might Be Used to Preserve Capital
I want to take a moment to discuss capital preservation portfolios but before I do, it's important to remind you that this discussion is meant to be a broad, high-level academic overview given that I am the managing director of a global asset management company. Specifically, I want to do this given our recent discussion about the importance of reserving some funds for capital preservation and the rundown of the four questions you should ask yourself whenever you add another capital preservation position to your investment portfolio.
I thought it might be useful to create a quick reference sheet for those of you who want to know which types of accounts or securities might be considered for the task under different circumstances. This is far from complete, and you will need to both make sure conditions haven't changed materially since this post was originally published as the information may be out of date as well as consult with your own investment advisor, but it should at least point you in the right direction and give you a rough idea of how you might want to think about the problem of principal safety.
1. Capital Preservation Portfolio Choices for Money You Need On Demand
For cash you need, or might need, or short notice - a few days or less - the two best options are going to seem prosaic, but they simply can't be beat under most circumstances:
- FDIC insured checking account
- FDIC insured savings account
Not only can you put aside hundreds of thousands of dollars (if you are intelligent and structure your account ownership correctly, you can actually succeed at increasing your effective FDIC insurance limits up to a couple million bucks; that is beyond the scope of our discussion), but you have branch offices that you can walk into if you need the cash, you don't have to worry about getting robbed, and, though this is not the case today, under ordinary market conditions, you would be earning some interest income on the capital.
It's hard to forget sometimes, but the world of zero percentage interest rates in which we find ourselves is a historical anomaly that is not likely to continue indefinitely.
Alternatively, you could keep actual currency stuffed in an envelope or locked in a safe deposit box, but that includes risk of loss and theft.
2. Capital Preservation Portfolio Choices for Money You Need Within the Next Few Months
If you extend your window a bit longer, we can add several additional options to your capital preservation shopping list.
- Short-term United States Treasury bills maturing in no more than 90 to 180 days, held directly at the U.S. Treasury through a TreasuryDirect account
- FDIC insured certificates of deposit maturing in no more than 90 to 180 days
- FDIC insured money market accounts (not money market funds; those are different)
As with the last category, the big thing here is to make sure your principal value is backed by the implicit guarantee of the United States Government, either directly or through the Federal Deposit Insurance Corporation. If another credit crisis hits, you want to be able to emerge with your cash, even if your bank fails. If you prefer to bank at a credit union, instead, you would look for NCUA backed deposits, which is the credit union version of the FDIC.
3. Capital Preservation Portfolio Choices for Money You Need Within the Next Few Years
In this case, your options get much broader as you can incorporate several different fixed income securities into the potential asset mix. Generally speaking, the prior category can also be added, you would need to select a longer maturity (e.g., FDIC insured certificates of deposit maturing in five years might be appropriate).
- Corporate bonds maturing no later than the earliest date at which you may need the funds
- Municipal bonds maturing no later than the earliest date at which you may need the funds
- U.S. Savings bonds (Series EE or Series I)
- U.S. Agency Bonds maturing no later than the earliest date at which you may need the funds
The greatest risks in this category are going to include bond duration caused by interest rate sensitivity, credit risk from the financial health of the bond issuer, and your accurate forecasting of when you expect you'll need the funds (go out too long and you will possibly suffer losses in a rising rate environment; stay too close to the present and you could leave quite a bit of interest yield on the table).
In all cases, you will generally want to avoid foreign bonds or foreign currency denominated instruments if they can be seized without recourse, as is likely to happen in the event of an emergency.
You'll also want to keep a close eye on expenses and taxes. If you are in the top tax bracket, by way of illustration, it is highly likely that the tax-free status of most municipal bonds is going to result in more net cash in your pocket than a higher yielding corporate bond so you'd need to break out a calculator and figure your taxable equivalent yield.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.