Here’s What Gold Can (and Can’t) Do for Your Portfolio
Gold has produced incredible gains in recent years. Last year, the precious metal gained 78%, making its five-year gain 200%. Those kinds of returns attract new investors, especially with gold acts as a hedge against inflation and uncertainty.
Those two factors can drag down stock portfolios, but they can turn into headwinds the price of gold. However, that doesn’t mean you should only invest in gold and ditch your other assets.
Gold doesn’t tick all the boxes balanced portfolio. A diversified asset allocation across multiple investment types can provide the performance your portfolio needs to achieve your long-term financial goals.
Physical gold does not provide cash flow
Retirees often live off their investments, but that’s a problem if you only have gold. Precious metals don’t generate cash flow like dividend stocks and certificates of deposit (CDs).
Gold investors will be needed sell their precious metals to cover living expenses. However, some investors live on dividends, meaning they never sell their equity. These investments can continue to gain value, and many dividend-paying companies raise their distributions each year.
While cash flow doesn’t matter much to young investors who live on their incomes, it matters a lot to retirees who don’t have the cash for an apprenticeship. That doesn’t mean you should avoid gold entirely, but the lack of income shows why you should you shouldn’t put all your eggs in one basket.
Stocks can outperform gold
While gold looks attractive because of its multi-year hot streak, it doesn’t always outperform the S&P 500. Economic cycles that reflect inflation and a calm climate favor stocks.
Equities also tend to outperform gold and other precious metals when some degree of certainty develops about major market news and world events.
Gold doesn’t always go up. Just as gold can rally during stock market corrections, this precious metal can lose value when stocks rally to all-time highs. Exposure to both assets allows you to benefit from both circles. Gold sometimes produces returns in line with stocks, but the precious metal’s low correlation with the market will make your portfolio less vulnerable to downside risks when you mix assets together.
Gold is still volatile
Although people consider gold as safe propertythat does not provide the same stability as CDs and other non-standard goods. Gold is a volatile asset that can experience significant volatility during high inflation and economic uncertainty. That’s because any news about those declining conditions could cause a sudden correction in gold.
Investing heavily in gold also leaves you vulnerable to sequence risk. This risk shows how retirees can be forced to sell more assets than expected if their portfolio is adjusted during the first year of retirement.
Your monthly living expenses will remain the same regardless of how your portfolio performs. Being forced to sell a lot of gold during a correction will limit your future and can accelerate how much your portfolio will be depleted in the coming years.
For example, if a retiree invests $1 million in gold and it goes up 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 to $1 million results in a $40,000 withdrawal in the first year of retirement. That’s the difference between a $760,000 portfolio and a $1.16 million portfolio based on these two scenarios.
Investing in gold and stocks leaves you less vulnerable in the former situation as those assets can move in different directions, acting as a hedge against others. However, having fixed income assets that can cover 1-3 years of living expenses is the best way to deal with the risk of sequence of returns.
This risk shows how dangerous it is to own a large collection of highly correlated volatile assets. Holding a lot of gold outside of many other asset classes will increase this risk.
Gold is less liquid than other commodities
Buying virtual gold presents another obstacle that further reinforces the need to diversify into multiple asset classes. That is because physical gold is not easy to eliminate. You have to find a dealer willing to buy physical gold at a fair price. Some retailers use a wider spread of physical assets.
You don’t have to worry about liquidity in the stock market, especially when you trade high volume indices and stocks. Household names like Amazon are much easier to trade for and tend to have a lower spread of asking bids.
Having more liquid supplies can be useful during emergencies. While you don’t need to focus exclusively on liquid assets, it is beneficial to have these types of investments in your portfolio.
Build a portfolio with gold and other assets
Buying gold won’t insulate your portfolio against a downturn, but it does provide a valuable hedge against stocks and fixed income investments.
The right allocation between gold and other assets depends on your financial goals and risk tolerance. Dividends make more sense for younger investors, while many older investors see a steady income closer to retirement. Gold serves as an important hedge in all these different categories, especially in retirement with a gold IRA.
Viewing gold as one piece of a comprehensive portfolio can lead to more upside while minimizing losses during economic downturns.
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