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 , 1975-20141-yr ReturnsRolling 3-yr. ReturnsRolling 5-yr. Returns10-yr. Rolling Returns
Best146.1%60.1%33.4%11.4%
Worst-32.6%-13.4%-11.3%-5.1%
% Positive57.5%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, 1975-20141-yr ReturnsRolling 3-yr. ReturnsRolling 5-yr. Returns10-yr. Rolling Returns
Best37.2%30.8%28.3%19.0%
Worst-36.6%-14.5%-2.3%-1.4%
% Positive82.5%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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My Money Matters
My Money Matters
5 years ago

I think Gold and Silver has it’s place in the portfolio as an insurance and not as an investment.

Ace
Ace
5 years ago

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.

My Money Matters
My Money Matters
5 years ago
Reply to  Ace

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.

Tamara
Tamara
5 years ago

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… Read more »

Johanna
Johanna
5 years ago

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… Read more »

Ross Williams
Ross Williams
5 years ago
Reply to  Johanna

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.

Jarrod
Jarrod
5 years ago
Reply to  Ross Williams

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… Read more »

Ross Williams
Ross Williams
5 years ago

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.

Fervent Finance
Fervent Finance
5 years ago
Reply to  Ross Williams

Haha. I’d have to agree Ross.

Beard Better
Beard Better
5 years ago

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.

Paul
Paul
5 years ago

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.… Read more »

nicoleandmaggie
nicoleandmaggie
5 years ago

Guess I will skip tomorrow’s post then. If I wanted ads for a bad investment, I’d watch Fox News.

Cybrgeezer
Cybrgeezer
5 years ago

On St. Patrick’s Day, gold is a fine investment … If you’re a leprechaun.

The Money Spot
The Money Spot
5 years ago

Good for gifts to wives though! 🙂

William Cowie
William Cowie
5 years ago
Reply to  The Money Spot

Along with diamonds, one of life’s best investments, then! Followed closely by roses and chocolates. 🙂

Dennis Frailey
Dennis Frailey
5 years ago

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… Read more »

Tamara
Tamara
5 years ago
Reply to  Dennis Frailey

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.

Frank
Frank
5 years ago

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… Read more »

Ross Williams
Ross Williams
5 years ago
Reply to  Frank

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… Read more »

Rail
Rail
5 years ago

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.

Scooze
Scooze
5 years ago

Who will be writing tomorrow’s post, Rush Limbaugh?

William Cowie
William Cowie
5 years ago
Reply to  Scooze

LOL!

stellamarina
stellamarina
5 years ago

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… Read more »

Beth
Beth
5 years ago
Reply to  stellamarina

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.

Ace
Ace
5 years ago
Reply to  stellamarina

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.

Rail
Rail
5 years ago

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.

Beth
Beth
5 years ago
Reply to  Rail

I respectfully disagree. Gold is valuable because people say it’s valuable. That’s learned behaviour, not intrinsic.

Dave
Dave
5 years ago
Reply to  Beth

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.

Cognitive Dissonance
Cognitive Dissonance
5 years ago

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… Read more »

Ross Williams
Ross Williams
5 years ago

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.… Read more »

Jane
Jane
5 years ago

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… Read more »

Ross Williams
Ross Williams
5 years ago
Reply to  Jane

“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… Read more »

Tamara
Tamara
5 years ago

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,… Read more »

Jane
Jane
5 years ago
Reply to  Tamara

That is what I was trying to say. That the increase in real value over time does not increase.

JPNWV
JPNWV
5 years ago

Take Gold into a store and try to buy something.

Let me know how much it is worth.

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