Be Aware of the Risks When Considering Gold in Your Portfolio
Have you heard this one lately? “Gold has returned more than 300 percent over the last decade. How is your IRA doing?”
If you haven’t yet, you almost certainly will. Gold is at all time highs. Concerns about the dollar and the global “flat” currency system (in which currencies are not backed by gold as they once were) have renewed interest in protecting wealth by owning that precious metal.
So, the question of the day is… do you need it in your portfolio?
As with any investment — be it gold, stocks, bonds, mutual funds, etc. — before you jump in, you need to know the answers to these basic questions:
- What is its purpose in my portfolio?
- How will I make the investment, and at what price?
- When will I know it’s time to sell?
If you haven’t already thought these questions through, the driver in your recent interest in gold is likely simply a fear of missing out, perhaps fueled by aggressive advertising by gold dealers. This is normal, but concern about missing the boat often creeps in after the ship has long since sailed.
So, to find out if gold is a fit for your portfolio, let’s cover the basics. First, here are some reasons that gold, as well as real estate and other “hard assets,” may be a sound part of your overall investment strategy:
- “Store of value” (inflation protection). You work hard for your money. Gold, since the beginning of recorded history, has been used to ‘store’ the fruits of one’s labor for future consumption in a way that maintains purchasing power. However, the required holding period may be lengthy; over the last several decades, gold has not always kept pace with inflation.
- Inflation speculation. One of the reasons for gold’s recent run-up in value is that its buyers speculate in gold not based on recent inflation rates, but on expectations of future inflation rates. During the 1970s, many people expected the period’s high inflation rates would continue well into the future. But when future inflation expectations began to drop, so did the price of gold.
- Diversification. Gold and other commodities tend not to move in the same direction as stocks and bonds. Gold is therefore considered a portfolio diversification tool.
For most of us, the best place to store the fruit of our labor for our emergency needs is cold, hard cash in a federally insured bank which is available when you need it, in a predictable amount. Gold must be considered more of an investment than a cash equivalent, so its place in a portfolio is more appropriate as a longer-term piece of the puzzle, than a substitute for emergency cash.
If you are thinking an investment in the yellow metal makes sense for the long term, here are a few things you should know before diving in:
- The market for gold is more risky than you might think. It is extremely volatile and often complex. Be aware that there is more nominal value in paper contracts for gold, than physical gold exists to be delivered! And the price of gold does not always move in consistent patterns.
- Because of the above, particularly if you are worried about protecting yourself from the remote prospect of a meltdown of the financial system; consider owning your gold in the form of the actual metal, instead of the paper alternatives and proxies, like gold mutual funds, exchange-traded funds (ETFs), etc. But keep in mind that you’ll incur storage and convertibility costs when you take delivery of the metal.
- Gold coins and bullion are considered, for tax purposes, to be a collectible. That means that gains on the sale of gold, as well as shares of gold exchange traded funds and mutual funds, are taxed at higher capital gains rates than most other investment assets.
Also — for the newly minted ‘gold bugs’ — consider that you may already own some — and not even know it! Several mutual funds own both gold stocks, and even gold (and silver, and other precious metal) bullion. As is often the case, allowing financial professionals to decide when to buy and sell on your behalf may be wiser than trusting your instincts.
Taking the longer-term view, consider that from its 1983 peak to the 1999 low, gold lost over half of its value. Stocks, bonds, and even ‘mattress cash’ for 16 years all trounced gold holders, as the hedge against inflation theory failed.
The gold enthusiast will rightfully point out that anyone would have preferred the gains in gold over the last 10 years, to the returns on stocks. There’s no denying those with the foresight to buy gold in the past decade will have done well — if they sell at today’s high price and lock in their gains.
But, how long will it last? Investors 30 years ago who feared that the high inflation of the period could continue on well into the future sought out gold as a buffer. Many bought in at high prices that wouldn’t be seen again for decades. As those investors learned, changing attitudes about the future can turn a gold rush into a popped gold bubble. So if you do invest, don’t grow too emotionally attached to your gold — or any other investment for that matter.
Robert Schmansky, CFP®
Financial Advisor
Northern Financial Advisors, Inc
Franklin, MI
Lee Baker, CFP®
Rick Kahler, CFP®, MS
Bonnie Hughes, CFP®
Rick Miller, CFP®
Tara Scottino, CFP®
Robert Schmansky, CFP®
Francis St. Onge, CFP®
Karin Maloney Stifler, CFP®, AIF®
Somnath Basu
Jude Boudreaux, CFP®
FPA Guest Blogger
Sam Hull, CFP®, ACC
Dave Caruso, CFP®
John Comer, CFP®
David Bergmann, CFP®
Joe Pitzl, CFP®
Chip Workman, CFP®
Saundra Davis
Gelasia Steed, CFP®
Aaron Coates, CFP® CIMA
Michael Snowdon, CFP®
Pamela Sandy, CFP®
Mike Branham, CFP®
Edward W. Gjertsen II, CFP®
Constance Stone, CFP®
Andrew B. Chou, CFP®
And you really get to find some real gold (which is planted) in the gravel. Mutual Funds
The dynamic with gold has changed since 2000 with the introduction of the EURO and subsequently influenced even more with the introduction of ETFs, especially the first gold ETF in the U.S. There are simply more places for people around the world to diversify out of the U.S. dollar than there was preceding the year 2000.
Since 1971 when Nixon took us off the gold (backed by) standard, and before the year 2000, there was no real competition to the U.S. dollar. Everyone had faith in the dollar and the government knew this. So adding a little debt to the budget each year became the norm. Not it’s at almost 12 Trillion. This of course doesn’t include unfunded liabilities and other bailouts funded by either taxes (congress approved) or inflation (Fed induced).
What many CFP’s don’t understand is that the typical advice they give (and this may not be you), is to put a certain percentage in stocks, a certain percentage in bonds and a certain percentage in cash. The stocks might be 80% U.S. and 20% international, the bonds are typically U.S. corporate and U.S. government and the cash of course U.S. (granted there are some who recommend real estate and even commodities so I am talking in general).
Adding these numbers up, you might have about 12% (20% x 60%) in foreign stocks that might (might) counteract the fall of the dollar. This means that you have 88% of the portfolio at risk of a dollar fall.
What insurance do portfolios today have to counteract this dollar fall?
Answer: Maybe some real estate (hasn’t done well since 2006) and possibly some commodities, but you never see too many financial advisors recommending gold. They may recommend TIPS, but that’s a separate discussion on what inflation really represents (CPI has been manipulated by various Presidential administrations).
Look at the chart of gold and the dollar index the last 10 years. They are inverse of each other.
Gold might be considered an investment by some, but it is insurance against the fall of the U.S. dollar and all of the government spending that seems to be unabated (real inflation). Once the dollar index falls below 72, one better have this insurance. Prudent diversification demands it.
10% into gold would be a good hedge against this and that’s not asking for much. Yes, gold is volatile, but your advice of physical gold is relevant. A holder of gold cares not that if falls to $700 from here on it’s way to $2,000 or more. It’s insurance. It has thousands of years of history behind it versus the dollars 38 short years of history without gold backing.
For any gold doubters, answer this question. Why do Central Banks all around the world carry gold? Do they know something financial advisors don’t?
I was a financial advisor for over 20 years and left the business to write about it and other economic and political issues of the day.
I’ve written quite a few articles on gold on my blog. My latest one even told gold “investors” of stocks that gold was getting toppy at $1,058 a couple weeks ago. I just call it as I see it.
The way I see it for the long term, is gold is in the second stage of its secular bull market and the dollar is in deep trouble because of our government, treasury and Federal Reserve policies. And today we have the Fed going for more power. What a wicked game we play….
Disclosure: I don’t sell gold. I just write about it.
No offense and would be happy to discuss further. But if the discussion relates to the 1971 to 2000 history of golds rise and fall, I deem it to be irrelevant to today’s market and government spending climate. Gold simply provides investors some peace of mind insurance just like auto insurance, home insurance and life insurance cover the “what ifs” in life.
[...] to reply to an article written by a CFP (Certified Financial Planner). His article was titled; “Will the Gold Rush Continue, or will Fool’s Gold Rule?” and you can read my reply to his article in the comment section of the “All Things Financial [...]