InvestorQ : You often hear financial advisors to add gold to your portfolio. But is there any risk if gold is not added to the portfolio?
Katherine Gonsalves made post

You often hear financial advisors to add gold to your portfolio. But is there any risk if gold is not added to the portfolio?

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Rutuja Nigam answered.
1 year ago

A high net worth Indian investor had been an avid investor in equities and mutual funds for a long time. During a recent visit abroad he found that a lot of his friends were investing in gold and they all believed that gold would be an important investment in the coming years. While the investor surely found these arguments exciting, he was not really convinced that gold could be a good investment. He had grown up seeing his family members obsessing over gold and jewellery. He had always considered gold an idle investment and was not convinced that gold could be an investment.

On his return to India, however the investor did speak to his financial advisor about the idea of buying gold as an investment. He was surprised when his financial advisor told him that gold must constitute at least 10-12% of his portfolio. He decided to delve a little deeper by accessing the website of the World Gold Council and prepared a list of five questions to discuss with his financial advisor. Let us now look at the importance of gold and why not adding gold to your asset list can be risky for you.

Gold is a good asset class and tends to outperform when there is global uncertainty

That has been a historical trend with gold. Between 1971 and 1980 when the world was racked by the Arab-Israel war, Oil embargo, Iran-Iraq war and Russia’s invasion of Afghanistan, the price of gold went by from $35/oz to $900/oz in a span of 10 years. Gold has typically been the only asset which holds value in times of global uncertainty. With crisis in oil, Middle East politics, Russia and in the South China Sea, gold may be a good idea as a safe haven.

Interestingly, gold is also good when currencies are becoming unreliable

During the last 8 years since the crisis, central banks of the US, EU and Japan have printed their currencies overtime. This has led to many currencies losing value due to too much supply of currency. Under these circumstances, gold is a great investment as its supply is finite and nobody can go on minting gold. Hence it will always have a scarcity value to it. In other words world currencies are losing value gold emerges as an alternate currency. That is a good investment case for gold.

Over a period of time, increasing demand will drive gold higher

Demand for gold comes from usage and storage. China and India continue to be two of the largest markets in the world in terms of jewellery demand. This is a kid of perpetual demand that will continue to drive gold prices. Storage demand comes from central banks and ETFs. Many central banks are buying more gold as they are unsure of holding too much of their reserves in dollars and euro. This storage demand will drive much of the demand for gold and take prices higher.

Gold can be held in physical form but non-physical form is a lot easier

In the past, one had to hold gold only in physical form. Protecting the gold had a cost and hence nobody was too keen to store gold. Things have changed in the last few years. Today you can hold gold in the form of Gold ETFs. These exchange traded funds (ETFs) actually hold gold in their vaults and issue units against this gold holding. The price of these gold units will move with the price of gold. Since you can hold these ETFs in demand format, there is not risk of theft, pilferage or loss of value. Currently, the Indian government also permits you to hold gold in the form of gold bonds where you can also earn a nominal rate of interest over and above the appreciation in price of gold.

Remember, it can be risky not to have gold in your portfolio

The investor concluded that it is actually risky not to have gold in your portfolio for a number of unique reasons. Firstly, gold does not move in tandem with equities or debt and hence it helps you diversify your overall investment portfolio from cyclical risks. Secondly, gold is a natural hedge against inflation. This will ensure that over a longer period of time, its real returns become quite competitive. Thirdly, unlike equities and mutual funds, in case of gold there is no invisible asset. The asset is tangible, standardized and measurable. By not including gold in your portfolio you lose out on these three major advantages. The crux of the argument is that is not possible to outperform by buying gold as there is no scope for outperformance within the asset class. However, allocating 10-12% of your portfolio to gold will give it greater stability and soundness. What is important to note is that gold is not a return enhanced but more of a risk reducer. In bad times, gold can be an outperforming asset class, which holds the key.