When and why you should own gold

When and why you should own gold

Here are three math-based guidelines to consider before adding gold to your portfolio:

  1. You do not have any bad debt (debt at an interest rate over 5%).
  2. You have at least two-months reserve in your checking / savings account.
  3. You have built up at least $500,000 in the Vanguard All World equity index

 

Why you should own gold

Once you check those three boxes, you should own gold because it has a low correlation to other assets. This means it moves differently. It diversifies your portfolio.

Up until 1975 gold was money (the dollar was backed by gold). Today, most U.S. investors have too little gold in their portfolios. That assessment might seem unusual. After all, aren’t precious metals the purview of gold bugs, those perpetual pessimists who insist a devalued dollar, hyperinflation and financial apocalypse lurk just around every corner?

The advice to hold gold doesn’t reflect any particular political bent toward gold, and it’s not driven by any desire to make a commentary on the profligacy of the federal government. The strategy is solely based on strong mathematical evidence to support the financial wisdom of holding gold.

 

How much gold is appropriate for you

Faculty at Washington University in St. Louis and Thomas J. Anderson analyzed the returns of three portfolios over the period of 1946 to 2013.

  • Portfolio 1: 75% stocks and 25% bonds.
  • Portfolio 2: 50-50 between stocks and bonds.
  • Portfolio 3: 60% stocks and 40% gold, levered (with debt).

The results were striking. On one hand, for those who needed less than a 3% distribution rate there was no difference in the probability of success. However, with a 7% distribution rate, Portfolio 1 had a 46% chance of success, Portfolio 2 had a 33% chance of success, and Portfolio 3, (with gold) had a stunning 90% chance of success. This is a huge difference.

You can read more about this research in Anderson’s 2015 book, The Value of Debt in Retirement.

 

So what can we conclude?

Your weighting in gold should be a function of your goals. If you don't need it, don't hold it. However, you would be foolish to rule it out if it helps your long-term probability of success. I do the math for you and factor in these probabilities when you complete my financial plan.

 

Tips on holding gold

Here are a few tactics for working gold into your asset mix:

  • Aim for an allocation between 10% to 40%. Consider following my specific suggestions in your plan. Don’t bother with allocations of less than 5%. That’s simply not enough to achieve the diversification benefits of gold. Do not hold more than 40%, it is too much exposure.

  • You don’t need physical gold. The iShares Gold Trust Fund (ticker symbol: IAU) is a low-fee exchange-traded fund that’s designed to reflect the price movements of gold. It owns the underlying physical gold for you.

  • Consider further diversifying by adding silver. If you’d prefer not to load up on gold alone, you can split your allocation to metals by adding silver. The iShares Silver Trust Fund (SLV) is another ETF that makes investing in silver easy.

    • If you are considering silver, it should be 25% to 50% of your gold position. For example, if you decide on a 20% position in gold, you could hold 5% in silver and 15% in gold.

  • Think of bitcoin as a separate asset class. Bitcoin soared to record highs in early 2021, and some refer to the cryptocurrency as “digital gold.” However, beware that the data about digital coins is limited. What’s more, there’s little correlation between bitcoin and gold. Surprisingly, their movements are largely unrelated. There is no need for a bitcoin vs. gold tug-of-war.
    • If you want to work bitcoin into your mix, make bitcoin at least 2% but not more than 20% of your net worth. And beware of buying at historic highs. You want to buy low and sell high, not the opposite. Read more about bitcoin here.

 

 


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