Don’t let gravity get you down

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“I never want to lose money.” This sounds like a modest and reasonable investment goal, one that would be far easier to achieve than one that, for instance, aims for significant growth over a long time span. But is it? Is it feasible to invest and never lose money? How would you do it and might you regret it?

Same dollars; different value

Preserving capital is trickier than it sounds. Even the goal itself is deceivingly complicated. In fact, what does capital preservation even mean?

There are two equally true but completely different answers.

  • A) Preserving a dollar total – If you start with a million dollars, capital preservation means never having less than a million dollars in your account.
  • B) Preserving purchasing power – If you start with a million dollars (that can be used to purchase a million dollars of goods and services at today’s prices), capital preservation means continuously maintaining a balance that can purchase that same basket of goods and services, no matter how prices change.

The difference between these two goals, of course, is inflation – a small number with a big consequence. If prices never rise, a million dollars still provides a million dollars of purchasing power 20 years later. But if prices rise by just 2 percent a year, a million dollars will only buy about half as much after 20 years.

Apples and oranges

Goal A is very attainable. Just put the money in any account that pays a guaranteed return that’s greater than any fees that may be involved. A passbook savings account or CD or Treasury bond will do the trick. Even a mason jar hidden in a cave could preserve your initial balance for a generation or two.

Goal B – never losing purchasing power – is a whole other ball of wax. Goal B means owning a portfolio that beats inflation all the time.

Inflation has been running around 2-3 percent recently, but historically has often been much higher. Assembling a portfolio that always beats inflation basically rules out risk-free investments. This is painfully clear today, with short-term interest rates at historic lows. Even a 30-year US treasury bill currently pays only about a 2.8 percent coupon. It (barely) beats inflation right now, but if inflation bumps up to 4 or 6 or 8 percent sometime between now and 2042, significant purchasing power will be lost.

(Not to mention the bite that goes to the taxman.)

Accept the laws of markets

A big part of responsible investing is realism. Goal A is realistic but not very practical. What good is a million dollars that only buys half of what you need?

Goal B just isn’t realistic, in my view. Expecting to preserve purchasing power over the long term without accepting the chance of losing money at some point along the way means assuming away inflation (as well as taxes and management fees).

Like it or not, we can’t assume away the aspects of investing that cause us discomfort, no more than a pole-vaulter can assume away gravity just because it gets him down

To maintain purchasing power, I strongly believe, demands a growth-oriented mentality and portfolio – a diversified mix of stocks, bonds and alternative investments. This approach involves risk, in fact it relies on it. Investors willing to accept the chance of loss earn the opportunity to participate when markets go up.

Next time we’ll discuss growth investing in more detail.

 

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