Deep down, many folks want the best of both worlds. We want the rich chocolate cake encrusted with bacon and deep fried. But we don’t want the bigger waistline that comes with it. We want the muscle-bound physique but don’t want to do the hours of hard exercise necessary to get it. We want to save more, but we don’t want to cut back current spending to do it. We want a free lunch.
In retirement investment planning, we want big returns, without the risk of loss.
Now, maybe it is possible to make a zero calorie deep-fried bacon cake (but we aren’t dieticians, mind you) but we can assure you growth with capital preservation is impossible. These two commonly cited investment objectives are polar opposites—never the twain shall meet.
Wanting growth means wanting your portfolio value to rise over time. In investing, reward (rising value over time) is married to risk, and divorce is not an option.
If you invest in stocks, you are likely to see growth over time. But you are also assured of seeing the value of your portfolio swing, sometimes violently and sometimes downward. Bond values also fluctuate with the movement of interest rates. There are no exceptions, only degrees of risk and fluctuation. Even fixed annuities come with the risk the insurer blows itself up.
There isn’t a guarantee politicians will forever be willing to bail out failing insurers like they did American International Group, Inc. (AIG). What that means for fixed annuity investors is uncertain. It is a low risk, but a risk nonetheless. (And, corresponding with that low risk, fixed annuities have low returns.)
Many people think of capital preservation as a safe bet as it’s more of a savings process, alleviating the risk of fluctuation. And if you are a saver, that’s ok! If your goals and needs for that money are very near-term (buying a home, emergency fund, etc.) then be a saver! You want next to no movement, no fluctuation in portfolio values. The tradeoff for that is you’ll get extremely low returns, if any.
But if you are creating a retirement planning strategy, capital preservation is probably a pretty unwise tactic, as inflation will actually have a negative impact on your original investment. Any retirement planning strategy promising to give you growth and capital preservation is basically offering you six-pack abs you get by drinking a six-pack a day. It’s impossible.
The higher the return, the greater the risk of volatility. That is the nature of investing and there is no magic strategy for overcoming it, as Bernard Madoff’s victims sadly found out. We perfectly understand the emotion behind combining these two conflicting objectives, but as an investor, rational expectations are a must. They are your single best defensive against hucksters, poor advice and bad investment options.
Simple fact: If your financial professional claims to have found the Holy Grail offering growth and capital preservation, don’t ask them for more details about it. Ask them instead for the recipe for their calorie-free, deep-fried, bacon-encrusted, chocolate cake.