Every investor inevitably faces a tough reality: no capital is ever completely safe. With the ongoing threats of inflation and stock market volatility, safeguarding long-term wealth becomes a daunting task. So, how can investors effectively preserve and grow their capital in such a challenging environment? Let’s dive into this complex landscape.
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The Challenge of Capital Preservation
Picture this: you’ve been entrusted with $1 million, and your job is to protect and grow it over the next decade.
The goal seems straightforward—maintain its real value and ideally see it increase. At first glance, stashing the money in a traditional savings account could seem like the simplest solution. But a closer look reveals a web of complications.
Historical data offers essential insights. From January 1900 to December 2024, inflation in the United States has averaged about 3.0% per year. This starkly illustrates the downside of hoarding cash: over a century, a dollar would lose its purchasing power to below four cents, leading to a staggering 96% loss. This scenario highlights the insidious erosion caused by inflation.
Many might think that a savings account is a safe bet, providing interest and peace of mind. And it’s true—savings accounts in the U.S. and other developed nations have generally kept pace with inflation, with average short-term rates, as reflected by U.S. Treasury bills, also hovering around 3.0% per year. However, averages can be misleading. Take the financial repression of the 1940s and early 1950s, for example, when artificially low interest rates compounded inflation, leading to a shocking loss of over 40% in real purchasing power for savers.
Understanding Risk Through Historical Context
The data is clear: perceived safety can be deceptive. Exhibit 1 illustrates the peak-to-bottom real returns of U.S. Treasury bills over a ten-year horizon, revealing that savings might not be as secure as one might think. As we approach 2025, we find ourselves in a new era of financial repression, where the inflation spike of 2022 coupled with lagging interest rates has resulted in a nearly 20% real loss for savers. Today, many are down about 10% compared to 2010 levels, with real interest rates nearing zero.
This historical context serves as a critical reminder that even seemingly secure assets, like savings accounts, can lead to significant, long-term losses. The hard truth is that capital is always at risk, whether you choose to save or invest. It’s a continuous gamble against inflation and market fluctuations.
As investment horizons stretch, the line between saving and investing begins to blur. What seems stable in the short term may not shield value over longer periods.
For many, government bonds are the logical next step beyond traditional savings. Typically yielding around 1% more than savings accounts, they are often viewed as a safer option compared to stocks. But safe from what? Historical trends since 1900 show that bond investors have also faced substantial hurdles. For instance, after World War I, soaring inflation undermined the purchasing power of government bonds issued during the war. Liberty Bonds, with their fixed low interest rates, became increasingly unattractive as rates rose in response to inflation, resulting in sharp declines in bond prices during subsequent economic downturns.
Long-Term Perspectives on Investment Risks
This cyclical pattern resurfaced after World War II, characterized by low interest rates that contributed to a prolonged bear market for bonds. The 1970s, often dubbed a “bond winter,” saw bondholders endure nearly a 50% real loss. This reality underscores a critical lesson: recovering from a 50% loss requires a 100% gain, a daunting task for any investor.
As we look toward 2025, the investment landscape is once again reflecting a “bond winter,” with cumulative real losses nearing 30% due to the early 2020s inflation surge and rising bond yields. Investors are constantly faced with a choice: either watch the market hit record highs or manage their way through drawdowns. And let’s not forget the stock market’s own disappointments; historically, the Great Depression wiped out nearly 80% of real wealth invested in U.S. stocks.
Even when markets do recover, the timeline can stretch over years or even decades, and not every downturn is followed by a swift rebound. Moreover, inflation can further diminish real returns, even when stock markets appear to rise in nominal terms. Exhibit 3 illustrates a history filled with market corrections exceeding 20%, with the 21st century alone seeing three drawdowns of over 30% in real terms. Such substantial and frequent losses only highlight the inherent volatility of stock markets, where the sudden nature of losses is well known to seasoned investors.
While equities generally offer better long-term returns compared to bonds, they also come with the potential for significant disappointments over extended periods. Recent research by Edward McQuarrie points out that even in the 19th century, stocks did not consistently outperform bonds, challenging the notion that equities are a surefire long-term investment.
When we analyze real losses across key asset classes—savings accounts, government bonds, gold, and equities—it’s vital to consider both short-term (one-year) and long-term (ten-year) risks. By employing conditional value at risk (CVar), a metric that measures average losses during adverse periods, we can effectively examine expected losses specifically below the inflation rate.
While savings accounts are often viewed as a refuge, they can quietly chip away at wealth over time. The average real loss over a ten-year period (CVar) stood at -17%. Bonds fared slightly better in terms of long-term performance but experienced deeper short-term drawdowns, with their worst ten-year loss hitting -49%. Gold, frequently seen as a safe haven, displays volatility in both the short and long run, yet still might serve as a valuable diversifier.
Equities, on the other hand, promise the highest long-term returns but also present the most substantial drawdowns, with an average loss of -15% and maximum one-year drawdowns reaching as high as -62%. Long-term investors may reap the rewards, but only if they can withstand severe interim declines.
The long-term implications are undeniable: all investments carry risk. The crucial question isn’t whether to confront risk, but rather how to manage it effectively. Diversification across asset classes—bonds, equities, savings, and gold—remains one of the few strategies in finance that can help mitigate risk without compromising potential returns. Even within a conventional 60/40 portfolio, equities are still the primary source of risk.
One alternative strategy to reduce stock market risk is to focus on stable companies, often dubbed “widow and orphan stocks.” These firms generally deliver consistent returns similar to bonds, but with a key advantage: their earnings can grow alongside inflation.
I’ve encapsulated my extensive research and writing on this investment style in my book “High Returns from Low Risk.” These low-volatility stocks may lag during bull markets, but they tend to outperform during downturns. While they may not be as “safe” as bonds or savings in the short term, they are generally less risky compared to the broader equity market. Historically, steady stocks have yielded impressive results, achieving a real return exceeding 10% CAGR from 1900 to 2025; however, future returns may be less promising due to current high valuations and historical debt-to-GDP levels.
A Balanced Approach to Investment Strategy
Interestingly, a portfolio fully allocated to steady stocks shows expected losses akin to a traditional 60/40 portfolio, but with lower downside risk. This alternative mix can effectively reduce the tail risk associated with equities, presenting an appealing option for investors in search of stability.
Ultimately, the ideal mix of investments depends on an individual investor’s risk tolerance and time horizon, allowing for customization to fit diverse preferences. The overarching lesson is clear: stock market risk is the leading source of long-term portfolio losses, and it can be alleviated through strategic allocations to bonds and stable equities.
Even the most secure investment will undergo periods of value loss. No portfolio is completely immune to real losses, but those that experience smaller declines instill confidence in investors, encouraging them to stay committed to their strategies. A well-rounded portfolio, particularly one with a significant allocation to low-volatility, conservative equities, offers a compelling blend of inflation protection, market stability, and long-term returns. The evidence strongly suggests that such portfolios significantly reduce real drawdowns compared to all-equity allocations and traditional 60/40 mixes, all without sacrificing long-term performance.
As you contemplate the challenge of preserving and growing that initial $1 million over the next decade, it becomes increasingly clear that the road ahead is anything but straightforward. A diversified investment approach, especially one that incorporates steady equities, provides the most effective shield against the multifaceted risks present in today’s financial landscape.
