What Gold Will and Will Not Do for Your Portfolio (and Why That Matters)

Gold has produced eye-popping returns in recent years. Over the past year, the precious metal has gained 78%, bringing its five-year gain to 200%. Those types of returns attract new investors, especially with gold acting as a hedge against inflation and uncertainty.

Those two factors can drag down stock portfolios, but they turn into headwinds for the price of gold. However, that doesn’t mean you should only invest in gold and abandon your other assets.

Gold does not check all of the boxes of a balanced portfolio. Diversified asset allocation across multiple types of investments can provide the functionality your portfolio needs to achieve long-term financial objectives.

Physical gold does not provide cash flow

Retirees often live on their investments, but that's a problem if you only have gold. Precious metals do not generate cash flow like dividend stocks and certificates of deposit (CDs).

Gold investors will have to sell their precious metals to cover living expenses. However, some investors live off of dividends, which means they never have to sell their equities. These investments can continue to gain value, and many dividend-paying companies raise their distributions each year.

While cash flow doesn't matter much for young investors who are living off of their salaries, it becomes more important for retirees who lack vocational income. That doesn’t mean you should avoid gold entirely, but the asset’s lack of cash flow demonstrates why you shouldn’t put all of your eggs in one basket.

Stocks can outperform gold

While gold looks attractive due to its multi-year hot streak, it doesn’t always outperform the S&P 500. Economic cycles that feature low inflation and a relatively calm geopolitical environment are more favorable for stocks.

Equities also tend to outperform gold and other precious metals when some level of certainty develops around major market news and global events.

Gold does not always go up. Just as gold can rally during stock market corrections, this precious metal can lose value while stocks rally to all-time highs. Having exposure to both assets lets you benefit from both rallies. Gold sometimes produces gains in tandem with stocks, but the precious metal’s low correlation with the market will make your portfolio less vulnerable to substantial drops if you group the assets together.

Gold can still be volatile

Although people view gold as a safe-haven asset, that doesn't give it the same stability as CDs and other fixed income assets. Gold is a volatile asset that can experience meaningful turbulence during the heights of inflation and economic uncertainty. That’s because any news about those conditions easing can suddenly trigger a correction for gold.

Heavily investing in gold also leaves you vulnerable to the sequence-of-returns risk. This risk reflects how retirees may be forced to sell more assets than expected if their portfolio goes through a correction during the first year of retirement.

Your basic monthly living expenses will stay the same regardless of how your portfolio performs. Being forced to sell more gold during corrections will limit your future upside and can accelerate how much your portfolio depletes in future years.

For instance, if a retiree invests $1 million in gold and it goes up by 20%, they end up with a $1.2 million portfolio. However, a 20% drop results in an $800,000 portfolio. Applying the 4% withdrawal rule on $1 million results in withdrawing $40,000 in the first year of retirement. That's the difference between a $760,000 portfolio and a $1.16 million portfolio based on the two scenarios.

Investing in gold and equities leaves you less vulnerable to the former scenario since those assets can move in opposite directions, acting as hedges for one another. However, having fixed income assets that can cover 1–3 years of living expenses is the best way to tackle the sequence-of-returns risk.

This risk shows how dangerous it is to have a large concentration of highly correlated volatile assets. Having a large concentration of gold without many other asset classes will amplify this risk.

Gold is less liquid than other assets

Buying physical gold introduces another obstacle that further strengthens the need to diversify into multiple asset classes. That’s because physical gold isn’t as easy to liquidate. You have to find a seller who is willing to buy physical gold at a fair price. Some sellers use wide spreads for physical assets.

You don't have to contend with liquidity concerns in the stock market, especially if you trade high volume indices and stocks. Household names like Amazon are especially easy to trade and tend to have low bid-ask spreads.

Having highly liquid assets can come in handy during emergencies. While you don't need to concentrate exclusively on liquid assets, it is beneficial to have these types of investments in your portfolio.

Construct a portfolio with gold and other assets

Buying gold won't make your portfolio immune to downturns, but it offers a valuable hedge that compliments stocks and fixed income investments.

The proper allocation between gold and other assets depends on your financial goals and risk tolerance. Equities make more sense for younger investors, while many older investors come to appreciate fixed income closer to retirement. Gold serves as a valuable hedge throughout these different phases, especially in retirement with a gold IRA.

Viewing gold as one piece of a complete portfolio can lead to more upside while limiting losses during economic contractions.

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