Even among professionals, there’s often confusion about what capital preservation means. Often you hear or read about products, strategies or tactics that allegedly offer “capital preservation and growth.” However, these are two utterly conflicting goals. You can’t do them both at the same time—not as a goal.
And if you believe capital preservation is your goal, ask yourself why? Capital preservation means your portfolio value should never lose value—not even on a daily basis—which requires the absence of volatility risk. That may sound nice at first blush, but volatility goes both ways—up and down. You can’t get growth without volatility.
Investors, particularly those new to the game but even some grizzled veterans, mistakenly presume bonds protect against downside volatility. Not so!
Bonds are traditionally less volatile shorter-term than stocks. But risks exist. First and most obviously, bond investors do face default risk—and losses can be total. In bankruptcy proceedings, bond holders can sometimes recoup something—but that process can be long and often fruitless.
Some bonds are deemed riskier than others—like so-called junk bonds. Historically, junk bonds pay higher yields, but the risk the firm goes kaput and fails to return principal or reneges on interest payments is higher. But even firms with pristine ratings can and do go bankrupt. Lehman Brothers enjoyed an “A” credit rating right up until the moment it collapsed. ...