What is Conservative Investment?
Today, with a plethora of investment options available, it is difficult to choose. Investment decision-making is a product of various factors such as risk appetite, reward expectation, time horizon, age, tax planning, and liquidity. The objective and preferences of an individual determine the investment plan. The most important factor for decision-making is the degree of risk.
Numerous strategies cater to risk levels for each type of investor. Conservative investment is one such strategy.
What is a conservative investment?
The definition of conservative investment is an investment strategy that ranks capital preservation over capital growth or market returns. The focus of conservative investing is on stability and protection from market fluctuations.
Investors with a low or medium risk tolerance prefer conservative investing. Consequently, the return from conservative investment tends to be lower than from aggressive investing. Typically, investors nearing retirement or an investor with a mortgage or outstanding debt tend to be conservative.
Aggressive investors may prefer conservative investment if they view that markets will take a negative turn as a defensive strategy. Conservative investing may also be adopted during economic turbulence or market distress to stabilize investments.
Popular conservative investment strategy include the preservation of capital and current income. Capital preservation prevents capital losses, whereas the current income strategy identifies investments that pay above-average distribution. The current income strategy is steady and applied to various instruments across risk spectrums.
Conservative Investment Instruments
Instruments for conservative investments are as below:
- Cash and cash equivalents – Money market instruments such as treasury bills, certificates of deposits, and high-yielding savings accounts are some of the most conservative instruments. The government guarantees such investments, and they are virtually risk-free. The interest rate is much lower than other investments.
- Government bonds and securities – Conservative investors use securities issued by central and state governments, municipal corporations, and local authorities. These are medium-term to long-term instruments with a periodic interest income.
- Corporate bonds and deposits – Corporate bonds and deposits are other avenues of conservative investment. The risk associated is higher than with government bonds and securities. The credit rating assigned to such instruments indicates the level of risk associated with such instruments. The return from corporate bonds and deposits is higher than government securities.
- Conservative stocks – Blue-chip stocks are shares from relatively stable and established companies. The risk associated with such shares is much lower. Marquee stocks from defensive sectors such as healthcare and FMCG are conservative instruments. The high-dividend stock also generates current income periodically.
- Gold and Index ETFs – Gold and index exchange-traded funds are relatively safer than investing in individual securities. Unless the economy collapses, these instruments are not subject to a disproportionate upside or downside. The key is to invest gradually over a while.
Alternatives to Conservative Investing
Having understood the meaning of conservative investment, let's discuss the alternative to conservating investing.
Aggressive investing is the alternative to conservative investment. In contrast, conservative investing focuses on capital protection, and aggressive investing aims to maximize capital appreciation or increase the portfolio's value.
Aggressive investment strategies invest in small-cap and mid-cap stocks, startups and newly established technology companies, bonds, and securities with low credit ratings, derivatives, and emerging markets. The risk involved with aggressive investing is relatively more than in conservative investments.
For example, a capital growth strategy may invest 65-70% in equities, 20-25% in fixed income, and the balance in money market instruments. Even though the portfolio is well-diversified, the overall risk is higher than conservative investments.
One of the most important aspects of investment decision-making is the time horizon. Time horizon refers to the period of investment required to meet investment goals. It ranges from a few days to a decade.
Conservative investment is essential to align time horizons and financial goals. Investors close to funding a specific plan may switch from aggressive to conservating investing. Similarly, investors with a short time horizon may not be able to endure market volatility and prefer conservative investment.
Although the risk involved in a conservative investment strategy is low, the post-tax returns are significantly lower. In some cases, the post-tax returns may not beat inflation. A well-diversified portfolio is a combination of aggressive and conservative investments aligned with the investor's financial goals.
Frequently Asked Questions Expand All
A risk-averse investor tends to be conservative. Aggressive investors may choose to be conservative in case of extreme market volatility.
A conservative portfolio focuses on capital protection over capital appreciation. The risk involved in a conservative portfolio is low.
Warren Buffet is a conservative investor and manages to keep his wealth even in tough times.