Capital preservation through growth

John Osbon - November 27, 2012

As we discussed last time, it’s just not realistic to hope to stay ahead of inflation’s slow but persistent drain without assuming some risk. For investors whose first goal is to preserve capital, a growth strategy is the appropriate response, in our view. Here’s why.

By our definition, a growth strategy means a portfolio of diversified securities – stocks, bond, and alternative investments. A growth strategy uses both offense and defense to keep and grow capital through a wide variety of economic and political environments. A growth portfolio involves risk, which can be tuned to suit the investor by adjusting the proportion allocated to each asset class.

We feel an intentional mix of risky and less risky holdings is the best way to withstand negative investment events such as inflation, recession, and turmoil, and to capitalize on positive investment events such as economic expansion, rising profits, and reasonable interest rate returns.

Combat the silent enemies

As we discussed last time, losing purchasing power to inflation dooms any risk-free portfolio. Earning one percent a year on a CD creates a slowly rising account balance, but if inflation is running at three percent a year, the investor’s buying power falls every day of the week.

A growth strategy provides the opportunity to outpace inflation, and its unpopular cousin, a weak dollar. These silent killers never sleep. Growth investors assume some risk to overcome them.

Earn more and keep it

We also feel that a growth strategy is a smart way to practice tax efficiency, that is, keeping more of what you earn.  With growth, you don’t have to pay any gains taxes unless you sell.  Because a growth strategy entails only periodic selling to rebalance the portfolio, the slice that goes to the IRS is limited. Moreover, index ETFs – our favorite tool for portfolio construction – are designed for tax efficiency, with minimal capital gains distributions. (The largest ETF, SPY, has made no capital gains distributions in 19 years.)

More good news: dividends from the stock portion of the portfolio are currently taxed at the lowest statutory rate of 15 percent. It all adds up to keeping more of what you earn.

(Of course no investment strategy makes sense for every situation and scenario. A growth strategy typically provides some income and liquidity, but if the investor needs quick access to more than 10-20 percent of assets, the withdrawals can trigger taxes.)

If your goal is capital preservation, we suggest adopting a long-term growth mindset. A growth portfolio provides enough risk exposure to yield expected returns that beat inflation and preserve purchasing power.

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