Preservation of Capital and Asset Allocation Investing

by KenFaulkenberry

in Asset Allocation

Preservation of Capital and Asset Allocation Investing

Preservation of Capital and Asset Allocation Investing

Preservation of capital should be the highest priority goal of asset allocation investing. Unfortunately, despite a great deal of lip service, preservation of capital is one of the most neglected aspects of most asset allocation plans.

Asset allocation should be an important part of your investment risk management plan.

Why Preservation of Capital Matters

The bear markets of 2000-02 and 2008-09 have proven investors accept too much risk and most of the time do not understand compounding and the importance of exponential growth. This is a failure of the financial services industry and an excellent reason for investors to consider self-directed investing.

The laws of compounding make risk management a crucial part of investment management. If an investor loses 50% of a portfolio, a 100% gain is required to get back to break even. An investor that loses 10% of a portfolio requires only an 11% gain to get back to break even. Losing a large portion of a portfolio can wipe out many years of positive gains.

If You Lose:

Gain Required to Break Even:

























When you preserve your capital in a bear market, not only have you not lost a large portion of your portfolio, but you have capital to invest at much lower prices!

For instance, in 2008 the S&P 500 was down 52% at its worst point. The Arbor Asset Allocation Model Portfolio (AAAMP) had only lost 12%. The AAAMP still had 88% of its’ capital and was able to purchase stocks at bargain prices. A 31% rally still left the S&P 500 down 37% for the year, while the AAAMP ended the year with just a 2% loss!

Solutions to Manage Your Asset Allocation

Value Investing

The two most important words in value investing are: Price Matters! Whether it’s asset categories (stock, bonds, real estate, etc), industries, or individual investments it’s crucial investment decisions are valuation-based. The more you understand value, the better investor you will be.

Tactical Asset Allocation

Tactical asset allocation is changing the investment world. It allows the flexibility to consider valuations. Why do most people buy more consumer goods when the price is low and less when the price is high; but do just the opposite when it comes to their investments?

Maximum Drawdown

Maximum drawdown is the amount of a portfolio decline from peak to bottom.  Having a maximum drawdown policy is an important risk management planning solution. A maximum drawdown policy provides risk parameters in setting your asset allocation.

Preservation of Capital and Your Asset Allocation

Make preservation of capital your first priority in developing an asset allocation plan. Of course you must take risk; but paying attention to value, implementing a tactical asset allocation, and developing a maximum drawdown policy will help optimize your asset allocation.

Related Reading: Market Timing vs. Valuation Timing

Investment Analysis: High Probability Strategies

Investment Portfolio Management Basics

Written by KenFaulkenberry


AAAMP Blog by Ken Faulkenberry
Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record.
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