No. of Recommendations: 7
A quick response. If we're talking capital preservation vs capital appreciation, then we should define our terms.

For me, cap preservation comes in two forms: spurious and real. Spurious preservation is getting my $1,000 principal back on my 20-year bond. Yes, I've nominally preserved capital, but I've very likely lost purchasing power. So, when I buy 20-30 bonds, no matter how well they are guaranteed, my intention isn't to preserve nominal capital with reference to my principal, but to capture the intervening income stream as a means of appreciating capital, meaning, I'm putting my money to work and trying to make it grow. Yes, the principal will be worth something at maturity --it will have salvage value--, but the bulk of its value will have been consumed, the way any machine used in production gets consumed. Capital is a commodity meant to be put to work and a portion of it is going to get consumed.

Real capital preservation, OTOH, is determined by measuring preservation of purchasing power. How is that to be measured? Against one's own experienced rate of inflation. If computers are cheaper than ever, but I don't need one, their deflationary pricing doesn't reduce the inflation I experience on other items, like property taxes, which continue to increase. My bogey for inflation is 5%, which is just my best guess and working assumption. I have to make an after-tax, after-investment-expenses return on my investments of 5% annually or I'm not meeting an investor's most basic goal of capital preservation. Therefore, for me, a pre-tax 5.5% return, though it might be the best choice currently available, isn't preserving capital, because taxes will reduce my net returns below my inflation threshold. For me, a 5.5% CD isn't treading water. It's drowning, just as surely if I had been a steerage passenger on the Titanic and prevented from the lifeboats.

What anyone's threshold to distinguish cap preservation from cap appreciation will be is a function of their own unique circumstances, like state of residence, medical needs, etc. Retained gains in excess of one's cap preservation numbers can be considered one's appreciated gains. For me, capital preservation is a very aggressive goal, not a conservative one, and I pursue it with very aggressive means, like junk bonds rather than CD's and trading rather than passive indexing, with the expectation that I will err to the upside of achieving my preservation goals and be able to realize a bit of appreciation as well. For me it isn't an either-or thing, where preservation is the prudent and virtuous choice -- the Foolish one-- and appreciation is dangerous and greedy --the foolish one--, but a scalar value relating to sheer survival. It's a race in real time and I can always benchmark myself to determine whether I'm winning or losing. I'm not racing to attain the most, but merely to ensure enough, along the lines of the Voluntary Simplicty crowd, whose ethics and lifestyle I share, but not their investing naivete and ineptness. (Here I'm thinking the investment advice offered in Your Money or Your Life, an otherwise commendable book, whose heads and hearts are in the right place, but whose understanding of financial markets is woefully lacking despite Joe's reputed experiences on Wall St.)

If we lived in a truly non-inflationary epoch, where last year's prices were those that would prevail the rest of my life, I'd retire yesterday with every need met and most reasonable wants affoardable. But a world of stable prices is a fiction. In fact, some economists argue it isn't a desirable goal even if it were attainable (which I think it would be if that were our society's prime goal: a world of sufficiency for all.) But in the dog-eat-dog, real world of economic turmoil in which we all live and toil, the possiblity of achieving capital appreciation is the only way I have of ensuring that capital preservation is attained. I aim high so my arrow will hit its mark.

That's my response to the cap pres/cap appreciation issue, and it needn't be anyone else's, but the questions I raise ought to be relevant to the situations of others, as each of us makes the choices we have to, or are inclined to.


An aside. For me, capital comes in two forms: financial capital and intellectual capital. The former is necessary, but trivial. It's a dead and dumb thing that can't grow itself as even the humblest of plants can. It's the latter that has enduring, generative value, that both makes possible and husbands the former and that's why I hammer at this stuff so hard: to gain tools and skills, not mere dollars.
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