Mention conservative investing and what you often get is people who think that it means putting money away in the biggest, most stable enterprises, which in turn guarantees safety of principal. If the invested capital happens to also appreciate in value, that's even better. While it's true that enterprises (such as utilities) are defined as conservative, simply buying the large, well-known companies does not fulfill the goal of a successful conservative investment approach. Instead, such a viewpoint increases the confusion between acting conservatively and behaving conventionally.

SEE: I Have A Conservative Approach To Investing, How Should I Approach My IRA?

Definitions
Conservative investing, when understood and applied properly, is not a low-risk, low-return strategy. Investors must understand two definitions to appreciate the appropriate means by which to invest conservatively.

  1. A conservative investment is one that carries the greatest likelihood of preserving the purchasing power of one's capital with the least amount of risk.
  2. Conservative investing is the understanding of what a conservative investment is, and then following a specific course of action needed to properly determine whether or not particular investments are indeed conservative investments.

Where many investors falter in attempting to invest conservatively is blindly assuming that, by purchasing any security that qualifies as a conservative investment, they are in fact conservative investors. In other words, such investors simply focus on the first definition.

Such a viewpoint is limited and costly. A successful conservative investment approach requires not only an understanding of what a conservative investment is, but, more importantly, the correct approach to take in order to identify what truly qualifies as a conservative investment.

Characteristics of a Conservative Investment
If, based on the first definition, investors already know what qualifies as a conservative investment, one needs to know which characteristics define a conservative investment, which is where the second definition comes into play. There are three broad categories which investors can use to identify a conservative investment.

  • The Safety Factor
    Clearly, any conservative investment should be able to weather market storms better than the rest. In order to do this, certain characteristics must stand out. First, a business should have a low cost of production.

    Being a low-cost producer has the principal advantage that, when a bad year hits the industry, the chance of still churning out a profit or reporting a smaller net loss is available. Second, a business should have a strong research and marketing department. A company that cannot compete by staying abreast of market changes and trends is doomed in the long run. Finally, management should possess financial skill. In doing so, it will be well versed in things such as per unit cost of production, maximizing return on investment capital, and other essential elements of business success.

  • The People Factor
    This is a rather self-explanatory qualification for a conservative investment. But take notice that excellent people can only be beneficial after a business has demonstrated the signs of the above-mentioned quality. Take note of Warren Buffett's advice:

    "When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

    A small company can succeed on the heels of one or two exceptionally-talented people. But as a business grows, people throughout the organization must be counted if the company is to succeed and remain a conservative investment.

  • Characteristics of the Business
    This third quality requires a little more work for investors but is well worth the effort. Here, the goal for investors is to determine what advantages (or disadvantages) may prevent the business from growing and earning more profits, despite satisfying the first two conditions. One important thing to consider is the competitive landscape of the business; the existence of many competitors or the relative ease with which new competition can enter can affect the best of companies. The potential for excessive regulation could also be a game changer.

Even when a company satisfies the obvious conditions of being a conservative investment, you should always remember to consider this third condition. The following examples will illustrate this concept further.

SEE: Economic Moats: A Successful Company's Best Defense

Those Who Fail and Those Who Pass
Great examples of those businesses that pass the test include names such as Coca-Cola (NYSE:KO), Walmart (NYSE:WMT) and Johnson & Johnson (NYSE:JNJ). These companies have demonstrated time and time again the strengths of their franchises. Even more importantly, these companies will likely continue to have very favorable future prospects. Coke essentially competes with Pepsi and Dr. Pepper and no one else. What's more, it's unlikely that entrepreneurs are sitting in garages thinking about creating the next great soft drink company.

Because Walmart exists and succeeds, that should raise a red flag for most other retailers, save for Target. Remember Circuit City, which used to be number two to Best Buy in electronic retailing? It's now bankrupt, in no small part due to Walmart. Of course, once a passing company has been identified, the stock price only matters in determining the value gained.

The Bottom Line
Investing conservatively is not about simply identifying large, well-known businesses, but also going through a process that identifies why a particular company qualifies as a conservative investment. And as you can see from the names above, being a conservative investor can lead to some of the most dependable and respectable returns in the market.

SEE: Achieving Optimal Asset Allocation

Related Articles
  1. Mutual Funds & ETFs

    PSP: PowerShares Global Listed Private Eq ETF

    Learn more about the PowerShares Global Listed Private Equity Portfolio, a private equity-based exchange-traded fund, or ETF.
  2. Mutual Funds & ETFs

    2 No-Load Mutual Funds Suitable for Retirement (VIPSX; FTBFX;)

    Take a closer look at two no-load mutual funds that should be on the radar for retirees or potential retirees looking for security and inflation protection.
  3. Investing Basics

    Principal Trading and Agency Trading

    Ever wonder what happens behind the scenes when you buy or sell a stock? Read on and find out!
  4. Active Trading

    Warren Buffett: How He Does It

    We look at the Sage of Omaha's methodology for evaluating value stocks.
  5. Investing Basics

    Equity Investing For The Buy-And-Holder

    The buy-and-hold investment strategy requires investors to disregard their emotional responses to market movements.
  6. Active Trading

    What Is Warren Buffett's Investing Style?

    Learn the main principles that Warren Buffet uses in assessing a company. His take on value investing may surprise you.
  7. Insurance

    Breaking The Buck: Why Low Risk Is Not Risk-Free

    Money market funds have been assumed to be safe investments, and they are - but only to a point.
  8. Retirement

    Smart Ways to Tap Your Retirement Portfolio

    A rundown of strategies, from what to liquidate first to how much to withdraw, along with their tax consquences.
  9. Mutual Funds & ETFs

    Pimco’s Top Funds for Retirement Income

    Once you're living off the money you've saved for retirement, is it invested in the right assets? Here are some from PIMCO that may be good options.
  10. Mutual Funds & ETFs

    3 AllianceBernstein Funds that Are Rated 5 Stars by Morningstar

    Discover the top three mutual funds administered and managed by AllianceBernstein that have received five-star overall ratings from Morningstar.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  3. What is the 'Rule of 72'?

    The 'Rule of 72' is a simplified way to determine how long an investment will take to double, given a fixed annual rate of ... Read Full Answer >>
  4. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  5. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  6. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
Hot Definitions
  1. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  2. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
Trading Center