Capital Preservation
Capital Preservation

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. 

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Capital preservation
Capital preservation

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.

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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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