The U.S. economy is firing on all cylinders heading into 2018, but investors are still less than a decade removed from one of the most horrific market crashes in history. Buying gold is a popular way for investors to attempt to protect their portfolio from large stock market declines, but many investors don’t understand what it means to invest in gold and how much (if any) they should own.
The latest record to fall for a red-hot U.S. stock market is 2,600. After breaking above 2,200 for the first time ever in late 2016, nervous investors have watched the Standard & Poor’s 500 index topple 2,300, 2,400, 2,500 and now 2,600 on its path to a more than 15 percent year-to-date gain.
When the bottom fell out of the market in 2008, most investors were crushed. The S&P 500 lost half its value from its 2007 peak to its 2009 trough. In 2008 alone, the index dropped 38.5 percent. Gold prices, on the other hand, were remarkably stable. In fact, the SPDR Gold Trust (GLD) exchange-traded fund, a popular way to invest in gold, finished 2008 up 4.9 percent for the year.
Keep gold in a “satellite” position. Gold may have little practical use, but investors nonetheless perceive an intrinsic value in the precious metal that they don’t see in typical currency. Because of this perception, investors tend to buy gold when they are nervous about risks in other investments, such as stocks or bonds, or when they are worried about inflation.
When investors were concerned about falling stocks in 2008, the price of gold went higher. When they were concerned about out-of-control inflation in the U.S. dollar in the wake of the Federal Reserve’s quantitative easing plan, the price of gold climbed even further. From July 1, 2009, to Sept. 1, 2011, the GLD ETF tripled the return of the S&P 500, gaining more than 90 percent.
Since then, inflation has been kept in check and the economy has been on track. The S&P 500 has more than doubled, while the GLD ETF is down 30 percent.
With the S&P 500 so much higher than ever before in history, it’s understandable that investors would be considering a bullish bet on gold as a way to safely diversify their portfolios and reduce their exposure to the stock market.
Mike Loewengart, vice president of investment strategy for E-Trade, says the one thing investors should definitely not do is abandon their long-term investing plan simply because they fear a stock market downturn. “While it’s true gold typically has an inverse relationship to stocks – as in gold often rises when stocks drop – it doesn’t mean that gold belongs in every portfolio,” Loewengart says. “In well-diversified portfolios that utilize modern portfolio theory, commodities typically aren’t a dominating presence, but rather a satellite position that can mitigate risk or bolster returns.”
Nicholas Colas, co-founder of DataTrek Research, says gold tends to be an emotional topic for investors who are passionate about the risks they see in the economy and the stock market. But no matter how bad things get, Colas says long-term investors should try to limit their exposure to gold. “The typical weighting is 3 to 5 percent because gold does tend to provide diversification benefits during periods of inflation and/or market stress,” Colas says. “I would not recommend more than 10 percent, even if one really likes the notional security of gold.”
According to the American College of Financial Services, from 1972 to 2013, stocks outperformed gold when interest rates were rising, when they were falling and when they were flat.
Mark Hebner, founder and president of wealth advisory firm Index Fund Advisors, says there is an obvious reason why gold will never beat stocks over the long term. “In short, gold does not make a profit like a company does,” Hebner says. “You can relatively expect high risk and low return in gold compared to equities.” In fact, Hebner recommends that long-term investors avoid gold altogether.
The stock market can be extremely volatile and unpredictable in the short term, and it’s understandable that investors want to avoid the emotional roller-coaster rides from years like 2008. Still, rather than sinking a large portion of a portfolio in gold out of fear, investors should simply ignore…
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