A good investment portfolio has securities based on your investment preferences, diversified, and designed to generate maximum returns with minimum risks. Portfolio diversification is the need of the hour for a modern-day investor. Most investment experts recommend spreading your investments across various asset classes like stocks, bonds, gold, real estate, etc. to achieve optimum diversification. Even within each asset class, it is recommended to avoid investing with one theme or sector. The idea is to reduce exposure to any one sector of the economy. While diversification reduces the overall risk of the portfolio, there is a flip side to it – over-diversification. Today, we are going to talk about gold investments and help you determine how much of your portfolio should be invested in gold.
Gold as an Asset Class
Gold as an investment has been around for centuries. While the purchase of physical gold in the form of jewelry, coins, and bars was more prevalent traditionally, in recent years, digital gold, gold-based funds, and ETFs have caught the fancy of investors.
Gold has a low correlation with most other asset classes. Usually, when the economy faces a downturn and inflation rates rise, the buying power of money reduces. As a result, gold’s value starts increasing. Hence, investing in gold works as a good hedge against currency volatility and inflation since rising inflation rates usually result in an increase in gold prices. It is also a great way to diversify your portfolio since a crashing stock market does not usually imply a drop in gold prices. Add to it the simplicity of understanding gold investments, and you have an asset class that you wouldn’t want to miss.
In simpler terms, gold offers three primary benefits:
If gold is such a great asset, then why should you not have a gold portfolio alone?
The answer lies in the numbers. Let’s compare the average returns offered by gold over the last three decades. For the sake of an example, let’s assume that you had invested Rs.50000 in gold in 1990. How much do you think your investment would be worth today? We will spare you the calculation. It would be around Rs.2.5 lakh. Sounds good, doesn’t it? But, what if you were to invest the same amount in a stock market index say BSE SENSEX in 1990? Would have made more? The returns would have been phenomenally high. Today, that investment would have been worth around Rs.4 lakh. So, equity has offered better returns over time despite the volatility and market crashes.
However, there is a catch to equity investments. They are highly volatile and uncertain. Hence, investors need to hedge their portfolios against potential losses arising from such market volatility.
Now, the pertinent question is what percent of your portfolio should you invest in gold?
How Much of Your Portfolio Should You Invest in Gold?
First things first, you must design your investment portfolio in a manner that enables you to achieve your long-term financial goals. Hence, you need to create a financial plan that takes into consideration your financial goals, investment horizon, risk tolerance, and current portfolio composition. While many experts believe that investors should limit around 10-15 percent of their investment portfolio in gold investments, there are many factors to consider before making the decision.
One thing is clear, gold has not offered returns better than equities or even term deposits. However, its low correlation with other asset classes makes it a great hedging asset. Rather than recommending how much your portfolio should be invested in gold, we will share three strategies used by investors to determine the composition of gold in their portfolios:
1. The 5-10% allocation approach
If you are the kind of investor who is relatively confident in the economic growth of the country but wants to have some amount of insurance against unforeseen events causing a downturn, then you can allocate between 5 and 10% of your portfolio to investments in gold and gold-related securities.
2. The 15-25% allocation approach
Most investors find themselves a little skeptical about the economic outlook of the country. If you belong to this category of investors and find investing in the current economy having moderate-to-high risk, then you might want to allocate a slightly higher part of your portfolio to gold and gold-related securities. If you believe inflation rates rising could lead to losses or even a collapse of the financial system, then allocating around 15-25% of your portfolio to gold and gold-related securities could help you soften the blow.
3. The 30-50% allocation approach
If you think that the economy is headed downhill and the government debt rising inflation rates, and the Indian rupee losing value will eventually lead to financial chaos, then you might feel tempted to allocate up to half of your portfolio to gold and gold-related securities. While this can help during market downturns, it is important to ensure that you reallocate your gold investments every year and take the profits off the table. Remember, a portfolio with a high allocation to gold is as volatile as an all-stocks portfolio.
Remember, while investing never lose sight of your overall investment plan and financial goals. There can be times when gold investments look more lucrative than stocks and vice versa. The markets react to macroeconomic events and various other factors. Hence, it is important to constantly look at the risk-return balance of your portfolio and rebalance it to suit your preferences.