3 Benefits of having Gold Allocation in your investment portfolio | My Money Sage
If you are wondering whether Gold should be a part of your investment portfolio, then this is a must read for you.
Usually, Investors, when constructing a portfolio tend to limit their diversification strategy to equity and debt thereby ignoring gold, let’s evaluate if it makes sense to add Gold to your portfolio
Gold protects investors from stock market volatility and uncertainty. It has a negative correlation with stocks, so it provides essential diversification. Gold reduces volatility and optimizes long-term returns, but it cannot generate a regular income.
People prefer to invest in gold during periods of stock market uncertainty. Even though gold provides lower returns than equity, it ought to be part of your portfolio.
Let’s take a closer look at the advantages and disadvantages of investing in gold:
Benefits of investing in gold
It has a negative correlation with stocks
Gold and stocks tend to move in opposite directions. Gold is a safer investment than stocks, and it helps to diversify the portfolio. Most investors use it as a hedging instrument rather than as an investment.
It acts as a hedge against inflation
The value of gold tends to rise in line with the cost of living. When inflation is high, prices rise, stocks fall, and the value of currency declines. Most currencies have depreciated against gold over time. That’s why people like to invest in gold.
It acts as a hedge against geopolitical risk
While most asset classes lose value during a geopolitical crisis, the price of gold tends to rise during such periods. Gold prices also increase when people lose faith in the government. Investors see gold as a safe investment at times when geopolitical risk is high.
Disadvantages of investing in gold
It does not provide a steady income
Gold cannot generate a regular income, so it may not suit all investors. You will not get any interest or dividends that you can use to meet your living expenses. You will only enjoy capital appreciation when you sell your gold investments.
The price fluctuates based on global markets
Fluctuations in global gold prices affect the price of gold in India. The value of the dollar also impacts gold prices. The cost of your gold can go up and down due to these factors.
How to invest in paper gold
You can invest conveniently in paper gold, which offers several advantages over holding gold in its physical form. There is no need to worry about purity, price, and safe storage.
Here are three ways to invest in paper gold:
Gold exchange traded funds (ETFs)
Gold ETFs track the price of gold. Usually, each unit of a gold ETF is equal to one gram of gold. You will need a demat account to invest in a gold ETF. The expense ratio of a gold ETF is lower than that of a gold mutual fund, but you will have to pay brokerage and taxes.
Gold ETFs trade on the stock exchanges, so they offer liquidity and fair prices for sellers and buyers. However, the level of liquidity varies depending on the fund house.
Gold mutual funds
You can invest in an open-ended gold mutual fund in which the underlying asset is a gold ETF. A demat account is not needed to invest in a gold fund. A gold mutual fund may be the right option if you don’t have a demat account and are not inclined to get one.
The expense ratio of the gold ETF in which a gold mutual fund invests is part of the overall cost. The expense ratio of a gold mutual fund is higher than that of a gold ETF.Learn how to mange your money & create wealth, Download your FREE eBook now
Sovereign gold bonds
The Reserve Bank of India (RBI) issues sovereign gold bonds in multiples of grams from time to time. Gold bonds are available in both paper and demat form. The issue price of the bonds depends on the price of gold in the week before the subscription date.
The bonds are issued for eight years and provide an exit option in the fifth, sixth, and seventh years. The redemption price is based on the prevailing rate of gold at that time. Apart from price appreciation, gold bonds also provide interest @ 2.5% per annum.
Also read: Sovereign gold bonds vs Gold ETFs
Gold investments vs. equity investments
Equities have outperformed gold over different periods. A study showed that equities provided higher returns than gold over twenty years, ten years, three years and one year.
Gold attracts investors during periods of uncertainty and distress. It outperformed other asset classes during the global financial crisis of 2008.
Gold also outperformed equity after the tech bubble burst in 1999-2000. In India, gold plays the role of a currency hedge. It appreciates when the value of the Rupee falls against the US Dollar and vice versa.
Equities have been volatile, and investors are facing uncertainty on many fronts. They fear a repeat of the 2008 financial crisis, when both equity and fixed income fell. People rushed to invest in gold, raising its price.
However, a repeat of the 2008 financial crisis is unlikely, so it doesn’t make sense to invest too much in gold. Putting a significant amount in gold will reduce your long-term returns. Allocating 5% to 10% of your funds to gold ought to be enough.
Equity mutual funds and debt mutual funds will give you higher returns than gold in the long run. You will experience the power of compounding, and may also get better post-tax returns.
Equity tends to outperform gold but gold plays a vital role in the portfolio. Gold has a negative correlation with equity. It reduces portfolio volatility and optimizes long-term returns. You can invest 5% to 10% of your funds in gold to diversify your portfolio.