The impossible duo: Capital preservation and growth

In the stock market, volatility is much more often up than down. Eliminate the down and the up disappears also, always. Picture: NewsWire /Gaye Gerard

Seeking safety? Given the ASX and global stocks’ parallel, roughly 6 per cent drops from respective highs, and bears’ wrongly envisioning worse ahead, strategies offering equity-like growth and capital preservation may seem alluring.

Wrong. Like world peace or zero-calorie lamingtons, investment schemes promising capital preservation and growth are pure fiction. Yet many claim otherwise – especially now – trotting out sweet-sounding products doomed to deliver disappointment.

Successful investing requires rational goals and expectations. Simply: Growth and capital preservation can’t coexist in the here and now. Yet achieving growth probably means reaping both long term. Confused? Let me explain.

Compounding volatility, recent headlines hype global wars, the yen carry trade’s unwinding, too-slow-moving central banks including talk of possible RBA rate rises, the US’s election chaos, recession fears. On and on. It all makes “capital preservation” sound appealing. But a true capital preservation strategy is unwise for most people.

Why? True capital preservation means your portfolio’s value never falls – the eradication of potential volatility. Sounds nice! Eliminate stomach-churning wiggles like early August’s!

But volatility and negativity aren’t synonymous. A 1 per cent rise is just as volatile as a 1 per cent dip. In the stockmarket, volatility is much more often up than down. Eliminate the down and the up disappears also, always.

Consider the US’s S&P 500 index for its longest accurate history: Eliminating volatility means missing the 63.1 per cent of months and 73.5 per cent of years US stocks rose (in US dollars) since 1926. Or, similarly, the 61.7 per cent of months and 72.2 per cent of years Australian stocks rose in Australian dollars since good data began in 1969.

There’s no gains on the markets without occasional pain. Picture: Getty Images

True capital preservation is limited to near-cash-like vehicles, delivering ultra-low long-term returns. Even your big four savings accounts deliver meagre returns after introductory periods lapse. Any long-term growth? No! Ten-year Australian government bonds offer more yield, but they don’t eliminate volatility – as 2022’s big bond swoon proved.

Enter inflation. Australia’s averages about 4.9 per cent annually since data started in 1949. You saw higher inflation in 2022 and 2023, despite the last two decades averaging a much lower 2.7 per cent. Second quarter inflation instead sped to 3.8 per cent year-over-year.

As I type, 10-year Australian government bonds yield 4.06 per cent, while the 30-year delivers 4.58 per cent. So lock up your funds for 10 or 30 years now, and maybe you outpace inflation. But maybe not! Similar logic holds for US 10 and 30-year Treasuries’ respective 3.94 per cent and 4.22 per cent yields versus US inflation’s roughly 3.5 per cent long-term annualised average (and June’s 3 per cent year-over-year).

But volatility remains – and small inflation upticks could eat all your yield. Always remember: Even mild growth requires some volatility. Without downside volatility, there is no growthy upside. Never!

Hence, as unified investing goals, capital preservation and growth can’t coexist. Anyone claiming otherwise is wrong. Maybe they foolishly believe it – bad. Or worse, maybe they are hawking awful high-fee, capped-return products. Worst of all, maybe they are just crooks touting “upside with no downside”. Think: Ponzi-scheming rats like the US’s Bernard Madoff or Australia’s Melissa Caddick.

The more growth you need, the more short-term volatility to expect. Full stop. If you need liquid, equity-like growth, prepare for volatility. If you can’t, expect lower returns – which may require reconsidering your goals, and your saving and spending rates.

The good news? While capital preservation and growth don’t work as a combined goal, a growth goal can preserve capital over the long term.

Consider: In the 79 rolling 20-year periods from 1925 to 2023, US stocks have never been negative. Never! They average 806 per cent returns in those spans. Similarly, Australian stocks have never had a down rolling 20-year period since 1969, averaging 927 per cent.

The past never guarantees the future, but it does reveal if something is reasonable to expect. Human nature changes too slowly to diminish the profit motive’s power in any relevant timeframe. As such, stocks should continue reaping superior returns long-term.

Hence, a well-diversified equity portfolio is very likely to grow over the coming two decades – maybe a lot – despite occasional bouts of sharp negativity in route.

So take the long view. Across that very realistic investing time horizon, it may look like you achieved big growth while preserving initial capital. But it all stemmed from pursuing growth. Actually, pure capital preservation means curbing or capping growth. You may end up with less after inflation – achieving neither goal.

Anyone touting investments offering growth with capital preservation peddles the impossible. If it sounds too good to be true – like calorie-free dessert and guaranteed world peace – it almost surely is.

Ken Fisher is executive chairman of Fisher Investments.