When the stock market is soaring one day and seemingly teetering on the verge of collapse the next, as has been the case in recent weeks, many investors inevitably turn to gold. But if you’re looking to protect your portfolio from losses, following the rush into gold is a big mistake. Here’s why.
You’ve heard the reasons to invest in gold. It’s the ultimate safe haven, a storehouse for value, the standard of wealth, a safeguard against calamity. I could go on, but you get the idea. When times get tough and investors get scared, gold is often portrayed as a refuge, the investment that will shield your wealth from rocky markets, tipsy economies and political turmoil.
And that’s true, up to a point. The value of gold can soar during periods of financial uncertainty. Witness the more than 36% surge in gold’s price from January to September in 2011, a time when investors became increasingly concerned about the ability of countries such as Greece, Italy and Spain to handle their debt.
And because gold doesn’t always move in synch with stock prices, it can act as a buffer of sorts during big market selloffs. For example, when stocks tumbled more than 50% from their late 2007 pre-financial crisis high to their trough in early 2009, the price of gold climbed more than 25%.
But counting on an investment to provide ballast when stocks are capsizing and relying on that investment to provide your portfolio with broader protection against losses are two very different things. Fact is, if you’re looking to put your money in an investment you can count on to maintain its value in a variety of economic and market conditions, gold is not where you want to be.
Far from offering stability, gold is extremely volatile. As measured by standard deviation, the iShares Gold Trust, an ETF that owns physical gold, has been more volatile than the Standard & Poor’s 500 index. The practical implication of that high volatility is that investors who own gold can often face some gut-wrenching dips and dives in the value of their holdings. For example, after reaching a high of nearly $1,900 an ounce during the foreign debt crisis back in 2011, the price of gold began to slide and by the end of last year had slipped below $1,100 an ounce, a decline of more than 40%.
You can also experience a rollicking roller-coaster ride within a given year. If you go to the section of Kitco.com that provides historical gold prices, you’ll see that in 2012 gold started out at just under $1,600 an ounce, climbed to nearly $1,800 in February, slumped to less than $1,500 in May, rebounded to nearly $1,800 in October and slid again, finishing the year just below $1,660 (before skidding even more to finish 2013 at just over $1,200 an ounce).
In short, if you’re looking for an investment that provide protection in the way most investors think of it—that is, an investment you can count on to hold its value regardless of what’s going on in the economy and the markets—then gold definitely does not fit the bill. For that sort of protection, you’ve got to go to cash equivalents such as Treasury bills, money-market funds and FDIC-insured savings accounts or CDs.
That’s not to say you should put all your money in cash equivalents during tumultuous times like these. Unless you’re okay with earning anemic long-term returns, that would be a mistake. To build wealth and invest for retirement, you’re much better off settling on a mix of stocks, bonds and cash that jibes with your risk tolerance (which you can gauge by completing this risk tolerance-asset allocation questionnaire) and largely sticking with that mix through good markets and bad. But for the portion of your holdings that you do want to be absolutely, positively sure will be there in full when you need it (emergency savings, a downpayment for house you plan to buy soon, a reserve equal to one to three years of spending cash in retirement, etc.), gold simply won’t do. Cash is what you need.
One can make a case for investing a small portion of one’s assets (say, 5% to 10%) in some form of gold as a way to further diversify an already broadly diversified portfolio of stocks and bonds. But while such a portfolio may offer some advantages, I don’t see this as a move investors must make. And, in fact, I think the vast majority of investors can get along just fine with a conventional portfolio of stocks, bonds and cash (and get along even better if that portfolio consists of low-cost stock and bond index funds).
But on this score, let there be no doubt: If you invest in gold because you’re looking to put your money in an asset that will protect your principal from losses and shield it from the kind of wild swings in value we see in stocks these days, it’s just a matter of time before you will be disappointed.
Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at [email protected]. You can tweet Walter at @RealDealRetire.