How much Gold should an investor hold in a diversified portfolio?
We have written a lot about Gold over the years. Like everyone else, there is an inherent love affair with the shiny metal that has bestowed value to its owners for centuries. Lest we forget, the entire global monetary system was once on the aptly called Gold-Standard and many are clamouring for the days of old. Leaving that aside, the question we want to ask ourselves as investors, is not whether we want to hold Gold, but rather how much?
Generally speaking, there are three reasons why people invest in Gold and we shall explore all of them. Before we do that however, one thing has to be clear: whatever money we don’t put into Gold, we can put somewhere else. Investments that could conceivably outperform Gold are a so-called opportunity cost, and it makes the size of our allocation so critically important, if not potentially very expensive.
Number one, we expect the price of Gold to go up. It most certainly can and go on to set new record highs. Could it also go down? Yes of course, anything can happen when it comes to the future. Could I make more than I could lose? Not sure, and in any event that would depend on for how long you invest, which is called timing, and that’s a whole other discussion.
Number two, Gold protects us in times of market adversity. That is true sometimes, but certainly not always. As we saw in March, for example, Gold lost more than 10% when equities were down even more. The other problem is when to get out. Remember, if Gold indeed goes up in times of crisis, then when the worst is over, it should also go down again. We don’t always know when a crisis is ending, which makes exiting Gold so difficult, yet so critically important to the value it potentially brings.
What about Armageddon? For sure, when everything falls apart, Gold will be in demand. We saw this in the great wars, and when currencies lose their value, governments crumble and reserve systems fail, Gold will be one of the ultimate stores of value. Only problem is, few of us actually hold physical Gold. We own contracts that are traded on exchanges. And when we need to pay off the ferryman to bring us to safety from the fast approaching herd of rampaging zombies, he won’t take American Express. He will only want to get paid with the real stuff, the type you can carry, and there are clearly limits to that.
So how much Gold should we hold? As much as any of the other positions we have in our portfolio. Mathematically, we need at least twenty individual positions to be diversified. For most balanced investment portfolios, that equates to a holding in Gold of less than five percent. That’s as good as anything else we can do with our money in a world that is random.