Why is Capital Preservation Important?
Capital Preservation, This is perhaps the most important fundamental of long-term investing and this has been propounded by the biggest gurus of investing across the world. The popular lines of rule number one in the market being don’t lose money and rule number two being don’t don’t forget rule number one actually stems from this basic belief.
People often forget the importance of capital in taking very risky bets in the stock market. But it is fundamental to understand that capital is very difficult to accumulate and very easy to vanish and that has been the response or that has been the experience after any serious downturn in the market.
Where people actually burn up a very large part of their principal or capital also it’s equally important to understand that not everybody in the market has the psychological frame of a true long-term investor. people tend to panic when there are sharp draw downs in the market they don’t have the maturity to invest through cycles to go through pain and then to hold on to stocks and since all of us don’t have that similar psychological framework.
It’s far more important to focus on preserving your principle and capital and understand and realize that investing in the stock market is not about hitting the jackpot every time. But actually being remain standing after down cycles so that you can continue to be a long-term investor so capital preservation is an absolutely Key.
From the Psychological Standpoint, How does one go about Capital Preservation ?
Well the way to do it is actually to cut down risk on the portfolio and to embrace far greater diversification. I think people when they look at the stock market most investors they have a certain notion that their money will compound at 20% every year. and they will be owning certain stocks which will double and treble very quickly.
Once you dispense with that kind of an objective it’s easy to focus on preservation of capital, the way one should focus on once portfolio is to say that the stock market part of the portfolio is meant to actually be a kicker which will augment the overall returns in your portfolio.
The kind of return that you get from absolutely safe investments are usually not great, and therefore after inflation adjusting for inflation they don’t create a lot of wealth long term so basically the risk that you take on in the portfolio.
The purpose of that risk is not excitement is not to get MultiBaggers or hit jackpots but to simply enhance the average return of your portfolio to a respected respectable level of 10 or 11 percent. The moment you streamline this investment objective and distinguish it from the excitement of hitting jackpots it will be far easier to understand and implement the whole objective of actually focusing on preservation of capital our principal.
How Should One Position Their Portfolio to preserve capital or Principal?
Diversification is the absolute key in this one would suggest that at least 50% of one’s capital has to be in completely safe instruments and the remaining 50% can bear some risk let me explain. There are many fixed kind of instruments in the market which are the absolute blue-chip debt instruments which I invest in nothing but Triple A plus their returns might not be great but after tax after three years the returns are not too bad then there is fixed deposits there there are instruments like national savings certificates PPF absolutely guaranteed safe instruments.
The return on that adjusted will probably know beam no more than seven percent but fifty percent of your portfolio will have its principal safe and then you look at risk but even in that remaining 50 percent to keep your principal relatively unscathed.
You should consider things like index funds ETFs and Nifty ETFs because, they are by nature less volatile the chances of drawdowns are not very significant of course if the market Falls the ETF’s fall as well.
But index funds or passive investing should be a part of your portfolio then one should consider blue-chip funds which is should be another 15 percent so 15 percent is index funds say 15 percent more is absolute blue-chip large-cap funds which invest in quality and therefore the chances of principal being lost are actually much lower, and the last twenty percent of your portfolio can be broken up into maybe ten percent mid-cap or higher risk of diversified funds and ten percent direct exposure to equity stocks yourself which has the highest risk of principal drawdown.
The purpose of this kind of equity portfolio tailoring is that even in the high risk part of your portfolio twenty percent if that collapses by fifty percent your portfolio will not be down by more than ten percent and anybody can take a ten percent hit on their portfolio so preserve your capital put a lot of money in safe instruments and hope that the riskier part of your portfolio will enhance the overall return and take it up to something like 10% in a year and a 10% return is risk-adjusted a very acceptable long-term rate of return.
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