Investors have forever been plagued by concerns relating to currency devaluation, market downturn or economic recession. But through it all, investing in gold has often been perceived as a safer alternative.
Investors have felt more comfortable with real assets in times of economic uncertainty, because of which, gold has not only been used as a hedge against inflation but also as a hedge against hard economic times.
Gold has not only been used as a hedge against inflation but also as a hedge against hard economic times.
Why one opts for gold?
Gold is often recommended as a tactical diversification tool for investors when the markets are likely to overheat or slump due to cyclical factors, sudden catastrophic events, geopolitics or an outbreak of a pandemic.
But because gold is considered widely as a safety net, it can be considered a risky investment as well, as history has shown that the price of gold does not always go up, particularly when markets are soaring.
Investors typically turn to gold when there is fear in the market and they expect prices of stocks to go down.
Long/short term investment?
On a long term basis, holding gold as a significant portion of one’s portfolio could work against his/her investment goals, as gold is not seen as high yielding asset class.
But also consider this. Over the past 15 years, the price of gold has increased by 278 per cent, roughly the same as the 30-year return. Over the same period, the DJIA increased by 173 per cent and the long-term corporate bonds returned 65 per cent, which are both significantly lower than their 30-year returns.
So from this, it is safe to deduce that gold isn’t as good a long-term asset as let’s say stocks or bonds, but rather does well over the short or medium term.
On a long term basis, holding gold as a significant portion of one’s portfolio could work against his/her investment goals, as gold is not seen as high yielding asset class.
Portfolio’s gold allocation
One rule of thumb is to limit gold to no more than 5 to 10 per cent of your portfolio.
Depending on your situation and your risk tolerance, you might be more comfortable with a bigger or smaller share of gold in your portfolio.
From an asset allocation perspective, gold’s correlations with stocks and bonds are unstable and it is subject to large sentiment swings around periods of crisis and fear, so going beyond such massive shifts, is there value in holding gold?
There is value in holding gold in the long-term (in the unlikely scenario that all else fails), but the key is to not allocate much of your portfolio portion to gold. As discussed above, a 5-10 per cent allocation is ideal.
Does gold keep up with inflation?
Yes, it appears it does i.e. as the inflation rate is rising gold tends to rise and as the inflation rate is falling gold tends to fall.
However, gold doesn't always outperform the cumulative inflation over an individual decade. But it does appear to do well over longer periods of time.
So it is important to remember that although there is a good chance it may not beat inflation all the time, in the long term it evidently has.
Why gold funds?
When investing in gold funds, you won't directly invest in the commodity itself.
The most common means of buying gold directly is bullion gold coins/bars and the most common way to invest in gold indirectly (as an investment security) is through an exchange-traded fund (ETF).
Mutual funds, as you know, is simply a portfolio of shares that are pooled from multiple investors.
So to put it in another way, a gold fund is nothing but a mutual fund or ETF that invests predominantly in gold bullion or gold-producing companies.
Mutual funds invest little to no assets in physical gold.
Gold mutual funds typically hold stocks of mining companies.
A couple of the best gold mutual funds seen globally, in terms of long-term performance, long manager tenure and average to low expense ratios include Tocqueville Gold (TGLDX) and Gabelli Gold Load-Waived (GLDAX.LW).
Convenient returns
In case the fund invests primarily in bullion, or in stocks and bonds of gold manufacturers and miners, the price of the shares within these funds will majorly correlate to the spot price of gold.
The objective of this fund is to get returns from gold investments in a convenient way.
Gold funds which invest in physical gold offer investors the convenience of buying pure gold at low cost. There is no possibility of theft and you can sell these units at market linked prices anytime.
Popular gold funds
Investors interested in increasing their exposure to gold have many options to choose from. For example, a popular gold fund that invests directly in gold futures contracts is the SPDR Gold Trust (GLD).
For those wishing to invest in gold mining companies, a popular option is the VanEck Vectors Gold Miners ETF (GDX). In both cases, however, there are many more gold funds to choose from.
If you are interested in investing in India-based gold funds, there is an array of options.
Common types of gold funds
Gold funds can be of different types and they have been briefly explained below:
• Gold ETFs: The underlying asset in this type of funds is physical gold and hence, its value is dependent on the price of gold.
• Gold mining funds: These funds do not invest in physical gold but instead make investments in companies that are involved in the mining of gold. The returns from these funds depend on the performance of these gold mining companies.
• Gold fund of fund: These funds make investments in the units of gold ETF.
Perks and risks to investing in gold funds
Here is a popular example to clearly understand a major benefit of investing in gold stocks over gold as a physical commodity.
However, a frequent reminder from market experts is that gold should never be used as a market timing tool or as the sole vehicle for all your savings.
The price of gold has historically seen dramatic swings and the long-term average return for gold as an investment is only around 3-4 per cent, which is less than several benchmarks and major stock funds.
On the other hand, considered often a blanket rule and a well-proven fact is that gold can be a good diversification tool and an appropriate allocation for most investor portfolios is around 5 per cent.
While keeping these points in mind, here is a summarized list of advantages and disadvantages to investing in gold funds.
Advantages to investing in gold funds
• Investing in gold funds gives investors the benefit of exposure to the gold asset in an easy way
• Units of gold funds can be bought and sold at any time during business hours and from any part of the country due to which tax will not apply for the difference in the gold price
Gold can be a good diversification tool and an appropriate allocation for most investor portfolios is around 5 per cent.
• Investors can reap the benefits of the potential value of gold without possessing tangible gold
• Gold funds have been used as a hedge against geopolitical instabilities, currency devaluation
• It is a convenient way to diversify your investment portfolio
• It is a safe investment option as gold rates do not witness fluctuations too often
• You can use gold ETFs as a collateral while borrowing money from a bank or a financial institution
• Since each unit of gold ETFs are backed by pure gold prices, there is no risk to the purity
Disadvantages to investing in gold funds
• Lower returns
Unlike equities, gold may not give you exceptionally high returns. Basically, during a market crisis, the investment in gold is driven by the need for a safer haven.
As soon as the investor regains confidence, he might switch over to riskier options like stocks and bonds. After which the price of gold will decline. Thus, gold may not be considered a long-term option for wealth creation
• Diversification issues
Sometimes, investors are asked to diversify into gold to spread the overall risk of the portfolio.
However, gold may not be an ideal asset class for portfolio diversification, particularly for investors holding small to medium-sized portfolios, mainly due to the low optimum return generating capacity of gold as compared to other asset class.
For large-sized portfolios, a smaller amount may be allocated towards gold as a risk cover without harming the overall goal accomplishment.
During a market depression, you may think of a higher portfolio allocation towards gold. Conversely, as the market recovers, try shifting your allocations to better asset classes. A dynamic approach could help you in reaping the benefits of investing in gold
• Seasonal behaviour
Gold is prone to having seasonal response as far as performance is concerned. It gives relatively higher returns only during periods of insecurity in the market.
At all other times, you may find it lagging other asset classes. In such a scenario, gold can perceive more like an insurance cover rather than an investment opportunity.
