Some of the earliest civilizations traded gold and thousands of years later, the intrinsic value of this precious metal still plays an important part in a modern investing portfolio.
Unlike paper notes, you can’t just increase the supply of gold by printing more. Gold’s scarcity reinforces its value.
No other tradeable metal has ever provided the same effectiveness when hedging against market uncertainty.
Diversification is one of the most important principles of investing, and yet it is also the most misunderstood.
It’s a strategy that helps minimise risk and maximise returns by spreading your investments across different types of asset classes.
A basic example to highlight how diversification works; if you were to invest all your shares in a company that manufactures winter clothing, in the cold months your returns would be consistent.
Come summer, returns would fizzle out because no one is buying ski jackets to take to the beach.
However, if you split your investments – diversify them- between the winter clothing company and a swimwear company you’d receive returns throughout both the summer and winter months.
The role of gold in a diversified portfolio
When choosing how to diversify your portfolio, it’s important to look out for factors that may potentially influence your investment returns; in the example above, seasonal factors impact returns.
Gold is a smart choice for a diversified portfolio because in general, it has limited negative influential factors, which makes it a good hedge investment. Hedges are investments that offset losses in another asset class.
Gold often performs best when markets are down. According to Gold Silver, in most cases, the price of gold rose during the biggest stock market crashes in history. Many countries around the world even hold gold to hedge against their potential economic downturns.
Although risk and uncertainty are part of any investment, gold is a good option to create a solid foundation, stabilise a portfolio, and provide long-term gains.
Billionaire investor Ray Dalio, founder of fund Bridgewater Associates, suggested having 5% to 10% of your assets in gold as a good risk management strategy.
How much you decide to invest in Gold is dependent on your circumstances, including your financial goals, the time frame you are operating in, and whether you are an aggressive or conservative investor.
For example, if you are saving for a home deposit, and you have a large component of your savings in the stock market right now, it might be a good risk management strategy to have more than 5-10% in Gold for protection.
On the other hand, if you are just getting started, and your time horizon is a few decades, then 5-10% could be a good start.
How to get started investing in gold
Ready to get started with gold? Here are 2 common ways to add exposure to this precious metal to your portfolio. I have left out the third way to get exposure to the gold market, which comes from investing in gold mining companies on the stock market. We can leave them for another day.
Buy physical gold – gold bullion and gold coins
You can invest in gold by buying actual bullion and coins. In addition to diversification, there are benefits to buying physical gold assets.
No counterparty risk
Many investments are managed by a 3rd party which exposes certain counterparty risks. Not when you buy physical gold.
It’s the only financial asset that is not simultaneously another entity’s liability and no middleman is needed to fulfill a contractual obligation.
Stores its value
Physical gold also retains its purchasing power over long periods, while fiat currencies (money declared by a government to be legal tender) have a history of either going out of circulation or becoming debased (lowered in value) while remaining in circulation.
The price of gold is published and available 24/7
Anonymity and independence from online trading
You can purchase and store physical gold anonymously. No online trading account is needed, which means your investment can’t be digitally stolen or hacked.
Buying physical gold is fairly straightforward but there are costs to consider, such as storage.
Buy gold-backed exchange-traded funds (ETF)
An alternative option to buying physical gold is purchasing Gold-backed ETFs.
Gold-backed ETFs represent a fixed amount of gold which are bought or sold just like stocks. They also offer more liquidity than a physical bullion or coin.
Gold ETFs are backed by physical gold. When a gold ETF purchase is made on the exchange, the entity involved at the back end buys the physical gold.
It’s a cost-effective way for beginners to get into the gold market. Gold ETFs can be bought and sold in very small quantities, whereas buying even a small amount of physical gold can be expensive.
The Limitation of Physical Gold Investments
There is one significant limitation of investing in physical gold investments. There is generally no income component from your investment, ie no dividends.
An investment in gold is purely about the price growing based on either risk or scarcity.
If an income from your investment is important to you, that is you are approaching retirement, then physical gold may not be what you are looking for.
The key factor to keep in mind is that an investment in gold is a risk management play, one based on taking advantage of downturns in other markets for capital appreciation in the gold price. When the gold market is moving up it can happen very quickly, the rest of the time it is a very boring asset to hold.
I hope this has helped explain why gold is an integral part of a diversified portfolio and an important investment whether you’re just starting or a seasoned investor.
As you can see there are multiple ways to become an investor in Gold, whether it is with physical gold bars, a gold-backed ETF, and one that we haven’t discussed here, buying gold mining stocks.
Ultimately it comes down to how you prefer to invest, how much you want to invest, and whether deriving an income from your investment is important at this stage of your investing journey.
Let me know what you think about Gold as an investment in the comments below.