In times of market stress, investors may consider buying gold. Doing so can potentially benefit some people, depending on their financial situation and preferences. But not everyone wins from buying gold, especially when the investment is made from panicking rather than critical analysis.
The ideal time to build and allocate a model portfolio would be in less volatile and stressful times when emotions aren’t controlling decision-making. Remember that Sailors outfit and provision their boats before the storm.
Investing in gold
In some cases, investing in gold literally means buying gold coins or bars, though that’s not necessarily the most liquid, secure or easiest way to invest.
For the average person, owning a fund (i.e., an ETF or mutual fund) that invests in gold is probably the easiest way to invest. There are funds that invest in gold itself only, others that invest in a combination of metals, and others still that invest in mining operations and the like.
For example, some investors might be inclined to stick to the stock market but want exposure to gold, and thus they could invest in equities of precious metals mining companies. These assets
might also hold appeal by paying dividends. Other investors might want to diversify their portfolios by buying a gold ETF, for example, that’s backed by physical gold but doesn’t require investors to actually store gold bars themselves. This type of gold purchase generally wouldn’t provide dividends, but the returns could come from an appreciation in value.
Pros
Under the right circumstances, buying gold can have several advantages.
- Potential inflation hedge: As inflation rises, purchasing power decreases. So, if you have cash, you’re effectively losing money. Gold, on the other hand, is often considered to be a hedge against inflation. As inflation goes up, so can the value of gold, which could be an incentive to move some cash into this precious metal.
- Potential hedge against difficult economic conditions: In addition to potentially hedging against inflation, buying gold can potentially help investors get through difficult economic conditions, considering the price might rise during these periods. That doesn’t mean gold will always go up when the economy looks shaky, but it could potentially help those who plan ahead.
- Opportunity for diversification: Some investors buy gold or buy silver (or both) as they work toward building a diverse portfolio. Rather than having all of your money tied up in one asset class, spreading it around to different types of investments could potentially help you better manage risk and return.
Cons
While gold can help add balance and provide hedges for some investors, there are also risks to
watch out for.
- Potential long-term performance lag: While gold might outpace other assets at times, it might not hold up as well to long-term price appreciation. If you’re trying to save for retirement, for example, then putting too much money into gold could hold back long-term gains if gold lags stocks.
- Fear-based decision-making: Another potential downside to gold is that there can be a tendency to turn to this asset when markets get shaky. That can cause investors to make decisions based on fear, rather than on what’s best for their long-term success.
- Complexity of adding an asset class: Choosing this asset class over others such as traditional equities or fixed income isn’t just a matter of picking which one you think will gain more. There are also considerations around risk, cash flow, taxes, etc. So, adding this asset class can also add some complexity to your investment decisions.
Bottom line
Gold does show some benefits as a diversifier to equities, as the below chart shows:
It has had a had a higher return than Australian bonds and at times has not been well correlated to equities. However, gold has quite high volatility – over the last 20 years the volatility of gold has been higher than equities and produced a lower total return. Keep in mind there is no income from gold, whereas bonds have lower volatility and do pay regular coupon payments.
Buying gold can make sense for some investors, but it might not be something that you want to rush into. Take time to consider your options, and if you do want to invest in gold, you can figure out how that fits into your overall investment strategy by speaking with your trusted financial advisor.
Dr Steve Garth
Disclaimer:
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