Should gold be part of my portfolio?
[Editor’s note: This is Part I of a two-part series on whether it makes sense to include gold in your portfolio. Part II is “Why gold should be part of your investment portfolio.”]
Humans have valued gold for several millennia, and that will likely continue. It is understandable, then, that a human such as yourself might consider trading some green for gold. I say, “Don’t bother,” and here’s why….
1. Gold isn’t a consistently good investment
The wisdom of an investment decision depends on when you buy and when you sell. This makes all kinds of things — from dot-com stocks to Beanie Babies — extraordinarily good investments … as long as you sell before prices plummet.
Gold is no different, as current owners know; it was a fabulous investment through most of the 2000s, but has lost a third of its value since 2011. This isn’t unusual. Check out the returns on an ounce of gold over the past 40 years, based on data from the Federal Reserve Bank of St. Louis. The rolling returns measure performance over various holding periods, each starting a year later. For example, five-year rolling returns are the average annual price changes in gold starting with 1975-1979, then 1976-1980, then 1977-1981, and so on. The “% Positive” is the percentage of times that gold was at a higher price over the indicated period.
| Gold , 1975-2014 | 1-yr Returns | Rolling 3-yr. Returns | Rolling 5-yr. Returns | 10-yr. Rolling Returns |
| Best | 146.1% | 60.1% | 33.4% | 11.4% |
| Worst | -32.6% | -13.4% | -11.3% | -5.1% |
| % Positive | 57.5% | 55.3% | 66.7% | 67.7% |
Most investments have short-term volatility and ever-present unpredictability, but gold is all over the place. Most investors would consider a decade long enough of a holding period to ride out the ups and downs of a volatile asset. However, a third of the 10-year returns for gold were negative. I don’t know about you, but I’m not thrilled to invest in something today that, historically, has a one-in-three chance of being worth less in 2025.
2. Gold isn’t an inflation hedge
You invest today in order to pay for something in the future. Thus, your investments will need to keep up with whatever that something costs years down the road. Unfortunately, gold may not do it for you.
Cast your eyes once again upon the table above and ponder whether an asset that loses value over many multi-year periods is an effective inflation-fighter.
Also, consider this: The price of gold reached approximately $850 an ounce in 1980, and then began a long decline that didn’t end until 1999 at around $250. Gold didn’t exceed its 1980 peak until 2008. That’s a 28-year period during which gold didn’t increase in value. Something that cost $1,000 in 1980 cost $2,600 in 2008 due to inflation, and gold did nothing to make up the difference.
3. Gold isn’t a “productive asset”
In his 2012 annual letter to Berkshire Hathaway shareholders, Warren Buffett described three types of investments. The first is what he called “investments that denominated in a given currency” — e.g., cash and bonds.
The second type are “assets that will never produce anything,” such as tulips (the subject of a 17th century speculative mania), houses, and gold. Buffett pointed out that the total value of all the world’s gold (170,000 metric tons) could be melded together to form a cube that is roughly 68 feet per side. Back in 2012, that cube would have been worth $9.6 trillion — enough money to buy up all the cropland in the U.S. as well as 16 ExxonMobils, and still have $1 trillion left over “for walking-around money.” A century later, all that land and all those oil companies will have produced trillions of dollars’ worth of food and dividends, but the gold will still be just 170,000 metric tons of metal.
Those farms and ExxonMobils are examples of Buffett’s third (and preferred) category: investments that make things or provide services and can charge higher prices during inflationary times. For the average person, the easiest way to do this is by owning pieces of hundreds of businesses via a low-cost index fund, a productive asset that Buffett recommends for 99 percent of investors, including LeBron James on CNBC a couple of weeks ago.
Here is a version of that table above, but using the return figures for the S&P 500 index instead of gold.
| S&P 500, 1975-2014 | 1-yr Returns | Rolling 3-yr. Returns | Rolling 5-yr. Returns | 10-yr. Rolling Returns |
| Best | 37.2% | 30.8% | 28.3% | 19.0% |
| Worst | -36.6% | -14.5% | -2.3% | -1.4% |
| % Positive | 82.5% | 84.2% | 86.1% | 93.5% |
The average annual return for the S&P 500 over the entire period was 12.1 percent (compared to 4.3 percent for gold), which includes the cash that most companies pay their shareholders in the form of dividends. Historically, dividends have grown at a rate that meets or beats inflation. Why? Because companies charge higher prices over time.
Back in 1980, gas cost $1 a gallon, a new car cost something like $6,000, and $9 got you into the Magic Kingdom at Disney World. As prices have risen over the years — it now costs more than $100 to see Mickey up close and personal — companies have made more money.
You won’t receive such increasingly bigger checks from gold. It doesn’t fuel cars or fill bellies. It doesn’t provide transportation or entertainment. Yes, it looks pretty; but as Buffett wrote in that 2012 annual letter, “You can fondle the cube, but it will not respond.”
4. Miner losses, slow-growth jewelry, and taxes — oh, my!
Here are a few of my other beefs with bullion.
- Some folks choose to invest in companies that work in the gold biz (such as miners) rather than the gold stuff itself, since these are businesses that make money by providing services that will be required as long as humans dig stuff out of the ground to make other stuff. However, these companies’ fortunes often ebb and flow with gold’s luster, which is partially why the Vanguard Precious Metals and Mining Fund has lost money in each of the past four calendar years as gold prices have crashed.
- What about things made from gold, such as jewelry, that also have decorative, sentimental, and/or flaunting value? Whether an individual item is a good investment depends on many factors, including craftsmanship, taste, and all the materials used. But the U.S. Bureau of Labor Statistics does have a jewelry category in its calculation of the Consumer Price Index. An item that cost $100 in 1986 would be worth $166 today, according to this measure. That’s less than a 2 percent annualized return. Plus, such things have to be stored, secured, and insured, and are not easily converted into cash.
- Most forms of physical gold are considered collectibles by the IRS, and short-term gains are taxed as ordinary income while long-term gains are taxed at a 28 percent rate — higher than the 15 percent to 20 percent long-term rate on stocks. That higher long-term rate also applies to the widely held SPDR Gold exchanged-traded fund (ETF) with the GLD ticker (unless held in a tax-advantaged retirement account).
For these reasons, I would not advocate keeping gold in your portfolio; but tomorrow’s post will offer different perspectives on the subject of gold. Perhaps my reasoning will tarnish the luster of including gold in your portfolio a bit; but then again, it is always wise to consider different points of view before coming to a decision on matters like these.
What do you think? Should gold be part of your portfolio?
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There are 35 comments to "Should gold be part of my portfolio?".
I think Gold and Silver has it’s place in the portfolio as an insurance and not as an investment.
As an insurance? I hear people say this but it makes no sense. What are you insuring against? Total market melt-down, crash in the currency market, etc.? If so, what good will gold do you? If the economic system really crashes to the point that your money is worthless, your gold will have little value as well because gold is not functional. In that situation, food will be valuable. Shelter will be valuable. Gold will be decorative.
Currencies fail all the time but precious metals such as gold and silver are store of value. If you are expecting total melt down then having food stored is a good idea but problem with storing food is that it doesn’t last all that long.
What makes you think gold and silver are stores of value? If the world’s currency were to collapse, humanity would have to universally agree that gold is valuable as a currency. Based on the posts on this blog alone, it is obvious that there isn’t a consensus on the value of gold. Imagine two groups of people in an apocalyptic future: Group A that hoarded gold and Group B that hoarded products related to survival. There is no guarantee that group B would be willing to sell goods or services for gold. Group A would only have each other to trade with, and they only have gold.
Remember that bartering pre-dates currency and that currency is a product of a more “sophisticated” society/economy that has, for example, a banking system and a central government of some kind. If society were to revert to a primitive state, people would barter with useful things (tools, food, livestock, services) not metal.
Was it Buffett’s idea to classify houses as “assets that will never produce anything” (or provide services), or was that yours? Either way, I disagree. A house, merely by existing, provides the service of fulfilling somebody’s need for shelter, whether you live in it yourself or rent it out. Even if houses never went up in value – or if they always depreciated, like cars – it could still make sense to buy them as moneymaking investments.
With gold, on the other hand, you can make useful things – dental fixtures, electronics – but you can’t do that with gold that you simultaneously own as an investment, because once you put your gold in a circuit board and sell it to somebody, it’s not yours anymore.
Cars also provide a service. So do washing machines. I think he point about a house is that the value of the intrinsic service it provides never really increases. Its not going to provide housing to more people in the future than it does now.
A rental house or a car used in a livery service are productive assets. The house you own to live in yourself and the car you own for personal use are not – they are valuable items you are consuming through your own use. In the case of the house – or some extraordinary cars – you might be able to sell for a higher price than you bought it for. (And make no mistake – you will not see a higher sale price in the long term without spending money for maintenance.) But that doesn’t change the fact that the asset itself was unproductive for you during the time you owned it – you happened to catch a break on the price swings, that’s all.
A good explanation of why gold is really a terrible investment, unless of course your investment horizon is 1000 years from now. I can’t think of anything I would rather invest in if I was looking for it to still hold value in 3015.
Haha. I’d have to agree Ross.
This was a great primer on why gold is just totally foolish as an investment. That said, I don’t think this will stop the doomsday preppers and various strains of conspiracy theorists from bringing it up constantly.
Gold has always been a fear based investment, and I don’t get it.
Doomsday prepper’s odd affair with gold is one of the consistently baffling things I see. Lead, a simple, malleable, cheap, and useful (in the event of a world collapse) metal is a better investment if you think the world will end.
If your fear is hyperinflation, food will inflate as fast as gold. So why not invest in food? Sure, demand will collapse somewhat, but you gotta eat.
If your fear is volatility, buy an option. That is a direct bet on volatility and you still win.
Besides, if money (or society) collapses, we will have bigger problems than trading gold stocks or the value of our portfolios.
Guess I will skip tomorrow’s post then. If I wanted ads for a bad investment, I’d watch Fox News.
On St. Patrick’s Day, gold is a fine investment … If you’re a leprechaun.
Good for gifts to wives though! 🙂
Along with diamonds, one of life’s best investments, then! Followed closely by roses and chocolates. 🙂
Gold, like any commodity, is something you invest in on the supposition that someone else will pay more for it in the future. This is sometimes called the “greater fool” theory because in most cases the person who would buy it from you for more than you paid is a greater fool than you are. Commodity investing is little more than gambling unless you corner the market on something that people really value, and that’s very hard to do. You also have to be very good at timing the market in a commodity. Prices tend to fluctuate a lot and you need to know just when to buy and sell. If you view it as a hedge in case of an emergency, note that in the event of an emergency its value may not be what you had hoped. Suppose you had purchased oil ten years ago? If you had an emergency today and had to sell that oil, you would lose well over half of your investment.
Unlike many commodities, such as coffee, or food, or uranium, or oil, gold isn’t all that useful any more and its use is declining in industrial applications. In ancient times, gold was valued for its non-tarnishing properties and various other unique characteristics. But that was long before the era of modern chemistry. Today we can manufacture substances that are much better than gold for many of its former applications. So you are betting on the jewelry market. This means you are betting that the Indians and Chinese will produce enough offspring to soak up a lot of gold (they are the main consumers of gold jewelry).
Many argue that in the event of a cataclysmic catastrophe, such as collapse of our financial system, gold will have value whereas traditional currency and investments will not. But to be practical about it, how exactly will you use your gold in such a situation?
– If you have shares in a golf mutual fund, how will you gain access to that gold in the event of a true catastrophe?
– If you have gold bars saved away somewhere accessible, such as a safe deposit box, how will you use it to acquire food or other things? Shave off a little of it each time? Who would take it under such circumstances when food is the most precious commodity? My guess is that it wouldn’t last long, as you would end up paying exorbitant amounts of gold to get the things you need to survive.
– If you have gold coins (where you have already lost half of your investment due to markup and commissions), how many gold coins is a loaf of bread worth? They don’t tend to make gold coins in small denominations such as pennies or even in dollars. Your gold coin will, in theory, be worth hundreds or thousands of dollars. But how will anyone give you the correct change when you buy a loaf of bread? (Then again, the price of food will probably inflate so much under cataclysmic conditions that the gold coins will be spent rather quickly.)
If you want to be ready for a cataclysmic catastrophe, I’d recommend investing in non-perishable food, a few firearms, and lots and lots of ammunition.
An exceptionally well formulated argument, Dennis. I completely agree. But I think there is no convincing the gold lovers that the value of gold is largely a cultural construct. For example, the ancient Chinese greatly valued jade.
I’m glad to hear there will be another side to this post.
I don’t think gold is a panacea and I am not hoarding it expecting the zombie apocalypse.
But, there are a few things one should consider in support of it.
Firstly, Robert is absolutely right. Gold is a horrid investment. This is because it is by definition NOT AN INVESTMENT. As he states, via buffet, gold does not produce anything. By definition that makes it NOT an investment. Things you do invest in– yield real returns by production and services. As Kevin McKee says it, “You want your money to make money-babies.” Anyone who wants to “invest” in gold needs to know they are not investing. The gold portion of your portfolio is more accurately a portion of your SAVINGS. It is very similar to a bank account, CD or money market. It can lose purchasing-power (just like cash) but has better inflation protection then simple cash does. Gold is not an investment; it is savings and its function is much closer to that of your emergency fund.
Second, there are very few assets that have 1) inherent value, 2) zero specific counterparty risk and are 3) portable. During the great recession many companies went out of business and stockholders lost their assets. Several banks went out of business and if it wasn’t for FDIC insurance (and Congress’ decision to honor it) the depositors would have lost their savings. The large company I work for nearly went bankrupt, but we were insured by AIG. Unfortunately, AIG was also going bankrupt so we were in trouble. Effectively, the government’s decision to bail-out AIG saved our company and our jobs. What happens to your assets and retirement if the companies you have invested in go belly up? The question seemed academic before; but after 2008 and with mounting debts, counter-party risk is no longer simply academic. It is nice to have some part of your money in something that is in your control and will always have some value not dependent on the system to hold. It is a portion of your portfolio you can always pick up and leave with if things get bad.
Third, Modern Portfolio Theory suggests that we should have assets that move in value either inversely to each other or with almost no correlation, and then rebalance. Gold seems almost tailor-made to fit this purpose. Its correlation with stocks and bonds is either poor or inverse most of the time. It makes a perfect minority portion in a mixed portfolio of any real size. In 2008 when most peoples portfolios were dropping because of stocks and bonds; those who had A PORTION in gold and rebalanced were doing fine.
Gold isn’t a panacea. But it has some valuable financial properties that are almost unique in personal finance. As a minority portion it should have a place in any portfolio of size.
1) Gold is not like a savings account or cash. Both of those are highly liquid. Gold isn’t, at least not at its market value. Savings accounts and cash don’t have transaction costs like gold does. In fact savings accounts actually pay interest. Moreover, there are long periods when gold does not hold value relative to inflation. Given there are costs associated with buying, selling and holding it, its likely that overall it loses value on average.
2) Gold has NO inherent value. Its value is only what a “counterparty” will give you for it. It is portable. But only to the extent that you have physical possession and then you have costs associated with keeping it secure. Cash and credit are far more portable.
3) Gold contributes nothing to a portfolio that isn’t better contributed by real investments. Either cash or bonds are much better hedges against stock prices.
If you had rebalancing by selling stock and buying gold for the previous 20 years in 2008 and then sold the gold to buy stock, you would have lost a lot of money compared to having held onto the stock in the first place. You also would have lost money relative to moving money into savings accounts or bonds.
Gold is not a hedge against economic collapse. If all the companies in the S&P go out of business, what are you going to buy with gold? Planning for imaginary scenarios that are extremely unlikely is not a good investment strategy.
The only time gold looks like a good “investment” is when prices are at historic highs. But historic highs are rarely the best time to buy. They are great times to sell and sellers need buyers. So you are going to see a lot of FUD being pitched to get people to take an overpriced gamble they have little chance of winning.
I look a physical gold as insurance Vs. investment. I’ll comment tomorrow as I look at gold as worthy of possessing, although not as an investment in a portfolio.
Who will be writing tomorrow’s post, Rush Limbaugh?
LOL!
I would like to agree with Frank. Do not use gold as an investment but use it as an emergency savings. Even if you just have a few gold coins or rings it can be used for money in am emergency.
I would just like to add that if you are wanting to cash in your gold rings or coins do not take them to those local businesses advertising that they buy gold….you will only get about 40% of the value at most. They will then send it to a smelter business to get their 50% of the value. Instead you mail your gold direct to a smelter and you will get at least 90% of the value. I can recommend Midwest Refineries. Aloha
People might want to consider the fineness of their jewelry when trying to figure out how much its worth. A 12 karat gold ring is only 50% gold.
Most of the “worth” of jewelry is in the design and the hype, not the raw materials.
Use for money in an emergency? Not sure I understand that. I hope it’s not too much of an emergency if you have to mail your gold to a smelter and wait for them to send back a check.
Since the dawn of written memory gold has held an intrinsic value. Not a terrible thing to buy in my view. Cheers! P.S. I’m not Rush Limbaugh.
I respectfully disagree. Gold is valuable because people say it’s valuable. That’s learned behaviour, not intrinsic.
If you believe gold has no worth, what worth does a dollar have? It’s just a piece of paper. Same with stock – when a company goes down, stock is worth next to nothing.
Many gold bugs feel that fiat currencies (i.e. dollars) can and are being mass produced, whereas there is a finite amount of gold.
Gold is a hedge against the devaluing of fiat currency. Will it happen in our lifetime? Who knows, but many would argue it’s worth putting something against that bet.
Why do all Reserve banks hold gold, including your own? Answer me that question before you start knocking Gold completely:
This is a biased post. I have lived outside the US since 1998, with the exception of Grad school,and a few short breaks. It amazes how other cultures value gold. When I was in South Sudan,I was conducting an interview with a young women in her twenties. Out of no where I asked here, what is money? She responded money is something that has and keeps value over time. Like what? She went on to say Gold and Cows.I burst out laughing. She was Dinka, and cows are certainly wealth to the Dinka and the bride price, but she went on to say, gold was more portable and that families who could purchase gold, bought it, and hid it (gold) because her country had been so unstable for about 30 plus years. In Serbia, my girl friend’s mother told me of people pulling the gold fillings out of the dead mouths during the war. In Afghanistan, where I sit now, the Pashtuns in both Pakistan ( I also lived there)and here in Afghanistan have a saying Zan, Zar and Zamin, it tranlates to Women, gold and land. And you had better never touch a man’s Zan, Zar, or Zamin. Blood feuds last hundreds of years because of this. Men that can afford it, buy their brides LOTS of Gold from Dubai. And this my friend is why I will always hold 25% Gold, 25% Stocks, 25 Cash, and 25% stocks ( Index) funds. This portfolio has returned 9+ percent every year for the last 40+ years on record. I can live with this position,and so should you. Living in these unstable environments has taught, you NEVER know what can happen. There was a time in the 70’s when the Serbian passport was more widely accepted than the US passport, look at her now. Look at Greece,and Spain, and Portugal,and Italy, all world powers at some point,and Spain and Portugal both held the World’s Reserve currency for a time. History is littered with examples of why you should hold gold.
I don’t think your point was that investing in gold is similar to buying dinka cows, but that certainly seems to be what you are saying. And gold dental crowns may be a good investment as well.
“This portfolio has returned 9+ percent every year for the last 40+ years on record. ”
No, it hasn’t, you can find numerous years where that portfolio lost money unless you got very, very, very lucky with your choices of individual stocks.
We don’t know what will happen and we can, with the help of creative fiction writers, imagine all sorts of things. But there are a lot of real uncertainties to plan for, we might be dead tomorrow, not fanciful ones.
This is the classic result of the combination of fear mongering and false promises of security. Its the reason people should ignore all the media driven emotional advice and put their long term investments in index funds, their medium term investments in bonds or bond funds and hold enough in cash to meet their short term needs. The only gold they should buy is jewelry.
No, no, no! Gold should not be, or does not need to be in an investment portfolio. There would be only 2 reasons to buy gold. As stated as a hedge against inflation, and if you thought the dollar was going to lose all value. In college macro economics that was one of the things we learned, that the value of gold is a constant. If it will buy you a suit in 1910, it will buy you a suit in 2015. It doesn’t pay dividends or interest, and therefor can’t grow in value. The exception to that has been in the past decade with the proliferation of some electronic devices which use gold in the manufacturing. This has inflated the value somewhat but even that has leveled off.
“In college macro economics that was one of the things we learned, that the value of gold is a constant. If it will buy you a suit in 1910, it will buy you a suit in 2015”
That isn’t remotely true. The theory that it holds its value has no empirical evidence to support it at all. The actual value of gold in terms of what it will buy is both highly volatile and subject to inflation. It is entirely determined by what an available buyer will pay you for it at the time you decide to sell. As the graphs above show, there are long periods of time when that didn’t remotely keep up with inflation.
whaa? Gold is not an investment! It’s a lump of metal! It has no intrinsic value and limited industrial usage. If the world economy completely imploded and currency (yet another “thing” that has no inherent value asides from what we assign it), I would hoard food and survival gear, not gold! Seeds for crops are worth infinitely more than gold in an apocalyptic scenario….. Seriously, imagine trying to trade gold for a loaf of bread when the world economy has melted down and people are starving to death. What use does anyone have for a shiny metal?
By the way, I can spend a fortune buying gold jewelry (or diamond jewelry for that matter) but the moment I try to sell it, I’d be lucky to get 1/3 of the price I bought it for.
If you INVEST in gold (as in investing in commodities), the value will flux up and down but doesn’t really increase in real value over time like good companies do.
That is what I was trying to say. That the increase in real value over time does not increase.
Take Gold into a store and try to buy something.
Let me know how much it is worth.