Having Your Cake and Eating It, Too: Growth and Capital Preservation

In my business of investment advisery service, the first question we ask a new client is "What do you want to accomplish with your assets?" The vast majority of investors will respond with some variation of "I want to make as much money as possible, but I don't want to lose anything either." While we'd all like to achieve guaranteed gains without risk of loss, this is simply not possible. Instead, the key is to understand your objectives balanced against the amount of risk required to likely achieve those goals.

Client: I want to make enough money during my retirement to support my income requirements and provide enough money for my kids when I pass away. I also really don't want to lose what I have worked my whole life to accumulate. Can you help me?

Adviser: First, let's just get this out of the way: just about anyone who does any kind of investing shares your feelings. Everyone loves making money (growth), and no one I know likes losing it (capital preservation). However, it's impossible to guarantee both capital preservation and growth on a forward-looking basis. While the goal may have been achieved in hindsight (i.e. if an account grows over a certain period, both growth and capital preservation occurred), there can be no guarantee that condition will persist in the future.

Client: Isn't this one of the reasons people seek professional money management? This doesn't seem like an outrageous goal. Can you give me additional insight into your reasoning?

Adviser: OK, think about it this way. One of the concepts of basic finance is that attempting to achieve virtually any type of positive return requires the investor to accept the possibility of volatility and depreciation, especially over the short-term. Or, put another way, all investments involve risk.

Client: What if I just kept all my assets in a money market fund? Aren't I achieving the goal of preserving my capital and growing my assets in a safe investment like this?

Adviser: Putting your assets in 100% cash (or in a cash-like instrument) certainly accomplishes the goal of capital preservation, but saying that it provides any growth on a real, inflation-adjusted basis is a bit of a fallacy.

Let's say you have $200,000 in cash. For the next 20 years, you keep that cash in a money market fund that pays a return at about the same rate of long term inflation. Let's call it 3% per year. 20 years from now, you look in the account and, lo and behold, you have over $361,000! But just one problem: in 2027, $361 thousand can only buy you the same things $200 thousand did in 2007. That's no growth at all! This is because inflation has raised the baseline price on all goods over time. So this particular money market fund only kept pace with inflation, it didn't grow your assets at all!

In order to protect your assets from the erosion of purchasing power caused by inflation, you'll have to find some sort of investment that provides a level of growth above and beyond that of inflation. In other words, you'll have to accept some risk. If you don't want any risk, you can't expect any growth. See how that works?

Client: Yes, that makes sense. So, in your opinion, what can I do?

Adviser: After figuring out what the goals for your assets are, we have to work to find what level of risk is likely required to achieve those goals and if you are prepared to incur them. If not, you might need to reduce your goals. An investment advisor can help you find an appropriate balance and help you navigate the markets with your goals in mind. Your advisor can help walk you thorough a variety of scenarios to help gauge your comfort level with various strategies. At the end of the day, you should be able to find a strategy that maximizes the likelihood of meeting your financial objectives while still allowing you to sleep at night.

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The Adviser's Corner tackles a common situation or issue facing financial advisors and their clients.