When the term “investment,” is tossed around, the assumption generally focuses on some kind of asset that generates a reasonable rate of return, relative to the monies invested and potential appreciation when the investment is ultimately sold. However, there are some investments out there where return on investment is not the primary objective. These types of investments may be referred to as “defensive” investments where the primary investment objective is preservation of funds. Their goal, as part of an intelligent portfolio investment strategy, is to protect invested capital.
Capital preservation via lower-risk investments can be an important part of strong portfolio management. Warren Buffett, for example, is a huge believer in capital preservation. Buffett’s first rule of investing is not to lose money. His second rule? Don’t forget the first rule.
The Idea Behind Capital Preservation
The purpose of a capital preservation investment is to “protect the absolute monetary value of an asset as measured in the nominal currency,” according to Joshua Kennon1. In other words, capital preservation can help ensure that your investment doesn’t decrease – or entirely disappear.
One myth behind capital preservation is that it can be a stodgy portfolio investment; a money market account or certificate of deposit is suitable for risk-averse individuals, but not much else. In reality, capital preservation products may offer a safe haven from market volatility, weak economies, limited alternative investment options, and a variety of other sources leading to uncertainty.
And, capital preservation investments can be important part of planning for retirement and prudent estate planning. Individuals may reach a point in their lives where making money becomes less important than keeping what they already have. In short, protecting downside becomes much more important than seeking upside, and a capital preservation strategy can be a good way to protect assets.
Strategies for Capital Preservation in Real Estate
So how does capital preservation fit into real estate investing? For starters, adding a real estate allocation to a traditional investment portfolio has the potential to decrease risk compared to a portfolio comprised only of stocks and bonds2.
But simply adding real estate to your portfolio may not be much of a capital preservation strategy. Real estate investments have many risks, however there are strategies available for preserving capital within this investment sector. Investors employing a “defensive” strategy may seek lower risk-profile or “core” real estate investments and/or “recession-resistant” property types. The strategy may be enhanced by utilizing lower-leverage, non-recourse debt or investing without the use of debt at all.
Investors aiming to preserve their capital, may also seek to lower their exposure to any single property by diversifying their real estate investments. The relatively high dollar amount of individual properties may make diversification difficult to achieve for the average investor, however, it may be feasible via investments in Real Estate Investment Trusts (REITs), Syndicated investments and/or portfolios of Delaware Statutory Trust (DST) investments.
One of the most valuable capital preservation strategies available to real estate investors is the 1031 exchange, which allows investors to defer capital gains and keep their equity working for them. What better way to preserve capital than by deferring upwards of 30% or more in capital gains taxes?
Finally, by combining the strategies of a 1031 exchange and investing in a diversified portfolio of institutional-grade properties, plus the added capital preservation feature of liquidity, with proper planning, investors can do a 1031 into a REIT.
Portfolio Management
As with any investment strategy, there is a relationship between risk and reward. A strategy of capital preservations often comes with a “price” of accepting lower yield. While every investor has their own risk profile and unique set of investment objectives, an allocation to a capital preservation strategy can be an important part of overall portfolio management. While capital preservation might not represent glamorous, high-risk, high-yield investments, it can be a good tool for ensuring that the capital in your portfolio remains safe.
At Realized 1031, we recognize the importance of planning for the future. We stand ready to assist you with your real estate needs. Call us today at 877-797-1031 for assistance in both growing your wealth – and protecting it.
1 What Is Capital Preservation and Why Is It Important? Thebalance.com, August 3, 2016.
2 As measured by standard deviation in returns. Realized internal research on correlation of annual returns (1978-2015); Data: NCREIF Property Index (real estate), S&P 500 (stocks), 10-year US Treasuries (bonds)
