Should gold be a part of your portfolio?
Updated: Oct 28, 2022
Gold, the most sought-after commodity, is prized not only for its luster and physical properties but also as a popular asset class for investing, thereby making it an essential part of humankind.
Major applications of gold
Historically, gold has been used to make coins, bullions, and jewelry, but in recent times it has been used in a variety of less typical ways.
Awards, Jewelry, and Status symbols – The sentimental value and quality of gold make it one of the favorite status symbols to be adorned with. It has been put to use in wielding the most noteworthy ornaments and accolades like wedding jewelry, Olympic medals, Oscars and statues of religious deities, etc.
Coinage, Bullion, Backing – The first known use of gold in transactions dates back over 6000 years ago. Even early printings of paper money were backed by gold held in safekeeping for every unit of money that was in circulation. The gold standard was once used by many nations but it eventually became too cumbersome and is no longer in use. Dentistry and Medicine – Gold has been used in dentistry since 700 B.C for fillings, crowns, and orthodontic appliances because of the metal’s chemically inert and non-allergenic properties. In the medical field, small amounts of gold have been used in certain radiation treatments and diagnoses.
Electronics and Computers – The most important industrial use of gold is in the manufacturing of electronics. Because of its highly efficient property as a conductor and connector, gold is found in small portions in many electronic devices like mobile phones, television sets, GPS devices, computers, and laptops.
Gold as an investment portfolio constituent
The yellow metal has been considered a safe haven that investors can rely on during times of economic crisis. On most occasions, when an asset class like equity enters a bearish phase or shows signs of a downward trend, the value of gold tends to rise. Interestingly, Gold prices have seemed to grow around 11.5% on average in the years when the inflation was over 6% making it one of the best bets for hedging against inflation and global uncertainty.
This commodity is historically known to preserve investment value and protect capital when the economy is weak. During the Covid-19 pandemic in 2020, when equity markets worldwide took a hit, gold was one of the very few asset classes that were delivering positive and double-digit returns.
One of the major reasons why you should consider adding gold to your investment portfolio is because of its inverse relation with other asset classes which would act as the perfect cushion against market downturns, thereby diversifying your portfolio.
The above figure is a comparison of Sensex data with gold prices. When the equity markets had crashed by more than 50% generating negative returns, gold had produced positive double-digit returns. Especially during the global financial crisis when the markets crashed by -61%, the precious metal had gained around 40% returns to its investors. Similarly during the dot-com bubble, when the markets fell by -53%, gold had grown by around 15%. This shows the inverse relation between these two asset classes.
NIFTY 500 and GOLD
The three instances considered below are some of the historic stock market crashes. NIFTY 500 represents the top 500 companies listed on the National Stock Exchange of India. This index measures the performance of the broader Indian market.
We have considered this index to get an extensive view as this index is not just restricted to the large-cap stocks that are part of the Nifty 50, but also constitutes mid-cap and small-cap stocks.
Equity allocation – 100%
SCENARIO 2 Equity allocation – 85% Gold allocation – 15%
In each of these cases, the portfolio without gold has gone down by a huge margin, but the portfolio that has been diversified with gold has reduced the losses. During the dot-com bubble and financial crisis, the gold exposure cut down the extent of fall by 11%, thereby reducing the volatility in the portfolio. This shows the ability of gold with such a small allocation to minimize the extent of losses and maximize the stabilization of your portfolio during severe drawdowns in the equity markets.
How should you add it?
Buying physical jewelry cannot be considered an investment as it is bought for the sake of consumption. Purchase of physical gold coins or bars cannot be as beneficial as an investment due to the additional storage costs and making charges involved.
If you are planning to buy gold as a portfolio investment, we would suggest going for Gold mutual funds where you would receive units representing physical gold in an electronic form.
GOLD MUTUAL FUNDS
Gold mutual funds are open-ended mutual funds that invest in units of Gold ETFs that in turn invest in gold of 99.5% purity and generate returns. The gold mutual funds’ performance will depend on the fluctuations in the physical gold price.
Why choose Gold mutual funds over other alternatives?
· Transparent and close to the actual price of the commodity in the market · No storage costs, making charges, and purity-related concerns. · An investor need not worry about the safety and liquidity problems associated with holding physical commodities. · Easy to track the value of your investment as the NAVs of gold funds reflect the price of gold daily. · Flexible investment through SIPs that would help in capturing the ups and downs of gold prices make the most out of volatility. · Ease of redemption as the amount will hit your bank account in 5 working days. · Easier to rebalance and change the overall portfolio asset allocation · No minimum or maximum limit on investment
Gold plays an important role as part of one’s asset allocation due to its low correlation with other asset classes and so if other asset classes underperform, gold would counteract and stabilize the portfolio.
Investors who are investing in equity, but are not yet fully comfortable with the volatility can add some exposure to gold. Mutual funds are one of the easiest ways to invest across asset classes that help in diversifying your portfolio.