The concept of wealth preservation and the discussions that surround that concept usually happen with my clients either at or approaching retirement. Generally it’s a discussion that also happens concurrently with a risk tolerance analysis, but that doesn’t need to be the case. For example an advisor who’s hearing a young couple saying they want to preserve capital might confuse that with a conservative risk tolerance. Although that may be the case, it’s also quite possible that the client has a significant risk tolerance in the purest form of the discussion equity/fixed income ratio, but still wants to preserve wealth using defensive equity strategies. That client may have a need for higher returns, and a desire to preserve capital, and it may not be necessary, depending on risk tolerance, to move to a fixed income portfolio. In other words, preservation of wealth and risk tolerance are not the same thing, and most advisors will often interchange the two. Assuming the discussion is actually one of preserving wealth, and not one of reducing risk tolerance, the below factors apply.
The preservation of wealth discussion usually happens at the late stages of saving or in the retirement years for most clients because that’s when they start drawing on their income or are starting to think about it. The easiest way to move to a preservation of wealth strategy is to change the asset allocation in a portfolio and to increase the fixed income component. The problem with that solution is that forces the client to be willing to accept reduced returns, and most people can’t afford that. In reality, in my view, there are better ways to do it without sacrificing returns.
Staying away from speculative stocks and sectors. This is a fairly simple and obvious one, but if investors want to preserve capital, they should stay away from speculative sectors, stocks that aren’t profitable, stocks that are trading a crazy multiples, and stocks that haven’t yet clarified or explained what their revenue model will eventually look like. Many of the pure growth plays in the markets would have these characteristics. If you can’t explain how your company is going to make money, if you aren’t currently making money, or if you don’t have a plan on how to monetize your idea, it’s probably best to stay away if preservation of capital is important. In this case, I would suggest sticking to sectors that have proven long term track records of generating profits and sustained growth, along with a slowly increasing dividend.
Replacing higher Beta equities with lower beta equities. Generally, this would be equivalent to replacing growth equities with dividend paying equities. For example, there’s an index that exists called the TSX Low Volatility index, and it targets the 50 stocks in Canada that have the lowest volatility. Not only has it historically done as good or better than the larger TSX index, but it has done it with less volatility. In theory, the way it protects wealth is that if ever there’s a market correction, the stocks should drop less than the broader index.
Adding Real assets to the portfolio. Specifically, REITs and Infrastructure are two sectors that I’ve liked for a long time. Real assets typically don’t correct as much in downturns, and provide consistent tax efficient income. If you actually take a step back and think about what you actually own when investing in these types of companies, you own actual buildings or infrastructure projects with proven long term cash flows. I always ask myself, in 20 years, what will my asset look like, and generally when considering these types of investments, they look good and have a strong likelihood of having kept its value.
Using alternatives such as Equity Linked GICs. This would be for a client who wants to have equity exposure while having the comfort of the guarantee associated with GICs. Clients can participate in the upside of the markets while having 100% of their principle protected. An easy way to preserve capital is to have the entire amount protected, and this allows for that.
Using a consistent rebalancing strategy. This is another oldie but goodie, and a simple way to protect capital. Every time the market rallies and your asset allocation get out of whack, by rebalancing, you take some profits off the table, reduce your exposure to markets, and protect yourself in the event of a market correction.