Gold has been used as a store of value and a medium of exchange for thousands of years, making it one of the oldest forms of currency in the world.
Because gold is often seen as a “safe haven” asset, you see more “BUY GOLD!” commercials during times of economic and political uncertainty. “Gold IRAs” promise to protect your hard-earned retirement funds, making investors wonder if they should be buying gold.
Investing in gold is not without its considerations. It’s important to understand the risks and benefits before making any investment decisions.
What does it mean to invest in gold?
There are two main ways someone can buy gold. First is the purchase of physical gold (coins, bullion, etc.). Someone who does this might be interested in having a “real” currency in case of an economic calamity or they might prefer having physical ownership of an asset.
The second way to buy gold is through an investment vehicle like a mutual fund or ETF. Some of these funds invest in gold futures, while others are backed by actual, physical gold held in a vault somewhere. There are even some funds that allow an investor to redeem their ETF shares for physical gold!
For the purposes of this blog, we are exploring whether an investor should buy gold as an investment (with the expectation that the value will increase over time).
Reasons to invest in gold
The first question you should ask when considering an investment in gold is why? Are you looking to hedge against inflation, diversify your portfolio, or make a speculative investment for short-term gains? Each of these purposes may require a different investment strategy and time horizon.
1. Gold as an inflation hedge.
A popular reason to invest in gold is to hedge against inflation. In investing, an inflation hedge is simply an investment to protect against the erosion of purchasing power.
With this in mind, gold can be effective depending on your time horizon. Historically, gold has maintained its value over time. This makes it an attractive option for investors who are concerned about the long-term effects of inflation on their savings.
However, the relationship between gold and inflation isn’t as straightforward as you might expect. Inflation is not the only reason the price of gold increases. This was evident during the “great inflation” of 2022. While inflation surged, the price of gold was flat.
There are other inputs that also affect the price of gold. Central bank policy, interest rates, the strength of the US dollar, and supply and demand are also important factors. In 2022, surging dollar and interest rates likely muted the price of gold in a year you would expect it to shine.
2. Gold as a portfolio diversifier
A second reason to invest in gold is to diversify an investment portfolio.
Many investors have portfolios primarily consisting of stocks and bonds. These two assets typically display low or negative correlation with each other. This means the prices of stocks and bonds don’t normally move up and down in unison. If stocks and bonds always showed weakness at the same time, there’s no reason to invest in both.
But stocks and bonds don’t always provide negative correlation. They can be positively correlated over short periods of time (like 2022 when performance was bad for both) or even longer periods of time. Again, having positive correlation defeats the purpose of investing in both.
Adding gold to a portfolio can be beneficial because of its low correlation to stocks and bonds. When you add asset classes that exhibit low or negative correlation to your other investments, it can help to reduce overall portfolio risk. This can be particularly important during times of market volatility, as gold may help mitigate losses in other areas.
3. Gold as a speculative investment
A third reason to invest in gold is to speculate on price gains.
Though “speculative investment” sounds bad, it just means you are hoping for an investment gain, usually over a shorter period of time. Instead of committing to gold as a long-term holding, a speculative investment could last a few weeks or months.
However, the price of gold can be highly volatile, and short-term price movements can be difficult to predict.
Gold predates stocks and bonds and is thought to protect your money during times of economic stress or high inflation. However, gold doesn’t always provide the investment returns you would think.
Gold can be valuable as a long-term piece of your portfolio to hedge against inflation and act as a diversifier to stocks and bonds. However, it shouldn’t be the only investment in your portfolio. For younger investors with longer time horizons, assets such as stocks and real estate may offer better compounding growth opportunities. Investors looking to put together diversified portfolios should consider how gold can fit into their portfolio.
In conclusion, investing in gold can be a valuable addition to a well-diversified investment portfolio. However, it is important to consider the purpose of the investment, the form in which the investment is made, and the role of gold in your overall investment strategy before making any decisions. With careful consideration and a clear understanding of the risks and benefits involved, investing in gold can be a smart way to protect and grow your wealth over the long term.