Capital Preservation Strategy: Seven Tools and the Risk Each One Keeps

A capital preservation strategy puts not losing money ahead of growing it. In practice, that means owning assets whose price can't fall far, and accepting a lower return for it.

The hard part is that every capital preservation tool protects against one risk by taking on another. Pick the wrong trade-off and the client still loses money. Just more slowly.

What is a capital preservation strategy?

It's a plan built around one goal: the starting balance should still be there when the client needs it. Growth is secondary. Some clients need this for a house down payment next year. Others need it for the first five years of retirement withdrawals.

The key word is nominal. Most capital preservation investments protect the dollar amount, not what those dollars buy. That gap is where most of these plans quietly fail.

What are the main capital preservation investments?

There are about seven common tools. Each one trades a different risk for its stability.

1. Treasury bills and money market funds. Very short maturities, so price moves are tiny. The risk is inflation and falling rates.
2. Bank deposits and CDs. FDIC insurance covers up to $250,000 per depositor, per bank, per ownership category. Early withdrawal usually costs a penalty.
3. Short-term Treasury notes. One to three years to maturity. Slightly more yield, and some price risk when rates jump.
4. TIPS. Principal adjusts with inflation. But the price still moves with real interest rates, and longer TIPS can fall hard.
5. Stable value funds and fixed annuities. Common in 401(k) plans and insurance contracts. They depend on the issuer's credit and often limit how you can exit.
6. Buffer ETFs and structured notes. Options limit losses over a set period, in exchange for a cap on gains. Our buffer ETF guide covers the mechanics.
7. Rule-based exposure cuts. A systematic process moves part of a portfolio to cash when signals weaken. It stays invested the rest of the time.

The first five aim to hold value at all times. The last two accept market exposure and seek to reduce drawdowns inside it.

Is a capital preservation strategy the same as a conservative portfolio?

No. A conservative portfolio still owns stocks and bonds, just less of the risky part. A 30/70 stock and bond mix can still lose 15 percent in a bad year.

Capital preservation is narrower. It asks how much the balance can fall in the worst case, and caps that number first. Return comes second.

What happened to capital preservation in 2022?

2022 is the year that tested the definition. Stocks and bonds fell together, and the assets people called conservative weren't all conservative.

Calendar 2022 total returns, measured with index-tracking funds:

• 1 to 3 month Treasury bills: up 1.4 percent
• 1 to 3 year Treasuries: down 3.9 percent
• US aggregate bond index: down 13.0 percent
• TIPS index: down 12.3 percent
• 20+ year Treasuries: down 31.2 percent
• S&P 500: down 18.1 percent

Long Treasuries carry no credit risk at all. They still lost more than the stock market. That's duration risk. The Fed started raising rates from near zero on March 16, 2022. Long bond prices fell as yields climbed.

TIPS were supposed to be the inflation hedge. They fell 12.3 percent in a year when inflation hit 9.1 percent in June. The inflation adjustment helped. Rising real yields hurt more.

T-bills held their value. But consumer prices rose 6.5 percent from December 2021 to December 2022. So a client sitting in T-bills lost about 5 percent of purchasing power. Nominal capital, preserved. Real capital, not.

What did 2023 show?

The cost of staying put. In 2023, T-bills returned 4.9 percent. That finally beat inflation, which ran 3.4 percent for the year. But the S&P 500 returned 26.3 percent.

A client who moved everything to cash in late 2022 felt good for a few months. Then they gave up more than 20 points of return in one calendar year. That's the other way capital preservation fails. Not a loss on paper, but a gap that compounds.

How do you build a capital preservation strategy for a client?

Start with the date the money is needed. Then match the tool to it.

1. Money needed within a year. T-bills, money market funds or insured deposits. Price risk matters more than yield here.
2. Money needed in one to five years. A ladder of Treasuries or CDs that mature when the cash is needed. Holding to maturity removes the price risk, if you never sell early.
3. Money needed after five years. Pure preservation gets expensive here, because inflation compounds against it. Most plans accept some market exposure and manage drawdowns instead.

That last bucket is where sequence of returns risk lives. A large loss just before withdrawals start does far more damage than the same loss ten years later.

Can an ETF strategy preserve capital?

Not in the strict sense. Any fund that owns stocks can lose money. What some strategies do is cut exposure by rule, so the worst declines hit a smaller position.

THOR's indexes work this way. Each holding has its own signal. When a signal turns off, that slot moves to cash. It returns when the signal turns back on. The goal is to seek to reduce drawdowns, not to remove them. Our pieces on ETFs that go to cash and cash as a position cover the mechanics.

When does a capital preservation strategy fail?

Four ways, and all four showed up between 2020 and 2023.

• Inflation. The balance holds and buys less. 2022 cost cash holders about 5 percent in real terms.
• Duration. Owning long bonds as the "conservative" asset. They fell 31.2 percent in 2022.
• Reinvestment. When rates drop, T-bill income drops with them. Through most of 2020 and 2021, short-term yields sat near zero.
• Opportunity cost. Staying out of a recovery. Missing 2023 meant missing a 26.3 percent year.

Rule-based exposure cuts have their own failure mode. Fast drops can hit before a signal reacts. And a signal can stay off through the early part of a rebound. Whipsaw is a real cost, not a rare one.

Capital preservation terms

• Capital preservation: An investment goal that ranks protecting the starting balance above growth.
• Nominal value: The dollar amount of an investment, before adjusting for inflation.
• Real value: What the balance can buy after inflation.
• Duration: How much a bond's price moves when interest rates change. Longer duration means bigger moves.
• Reinvestment risk: The chance that maturing money must be reinvested at a lower rate.
• Drawdown: The decline from a portfolio's peak value to its lowest point before a new peak.

This article is for educational purposes only and is not investment advice. Index and market figures are historical. Past performance is not indicative of future results. All investments involve risk, including possible loss of principal.