“All that glisters is not gold.”
William Shakespeare, The Merchant of Venice
Sometimes, even gold doesn’t “glister” as much as we think. Gold prices have reached all-time highs lately amid worries of economic uncertainty. But is adding it to a portfolio a solid approach, or a fool’s errand?
As an investment, gold doesn’t provide cash flows, it doesn’t produce earnings, and it doesn’t effectively hedge inflation. It does, however, provide equity-like risk with bond-like returns, incur holding costs, and suffer poor tax treatment. For these reasons, we do not recommend an allocation to gold in an investment portfolio.
Let’s take a closer look at some of the reasons often used to justify the inclusion of gold as an investment:
- Inflationary hedge. An effective inflation hedge should experience a volatility of returns that closely tracks changes in the CPI (Consumer Price Index). Since 1970, gold has experienced extreme price volatility when compared with changes in the rate of inflation. A better inflation hedge could be TIPS (Treasury Inflation-Protected Securities) which are bonds whose principal value increases with inflation, as measured by the CPI. These bonds are backed by the U.S. government and are a way to preserve purchasing power.
- Returns. While gold’s returns can soar above stocks during isolated episodes of high demand, long-term returns are about on par with Treasury bills. T-bills, however, are some of the safest investments you can buy and have an extremely low standard deviation. From 1/1/80 – 1/31/25, gold returned 3.83% annually with a standard deviation of 17.15%. The FTSE 1 Month Treasury Bill index returned 3.86% annually with a standard deviation of 0.94%. By comparison, the MSCI World Index returned 10.54% annually with a standard deviation of 15.05% (source: DFA). Higher volatility than stocks but with a lower return than bonds? That is not a compelling investment thesis.
- Diversification. Including different asset classes in an investment portfolio generally increases diversification and risk-adjusted returns, if those asset classes are less than perfectly correlated (meaning that they react differently to various market conditions). While gold is not perfectly correlated to stocks or bonds, it has historically had lower returns and higher volatility as measured by standard deviation, compared to stocks over the long term. Given gold’s high-risk, low-return profile, there are better ways to improve risk-adjusted returns simply by crafting a well-diversified portfolio of stocks and bonds, with exposure to a variety of sectors, market caps, and geographies.
- Safety. Faced with a constant barrage of alarming headlines from news sources and social media, fear and anxiety can become ever-present companions. What if everything falls apart, banks fail, the stock market crashes, the dollar is no longer the global reserve currency? In a post-apocalyptic, Mad Max world you’d need real assets like gold, right? Perhaps it would be useful if it can be used as a currency of exchange in this hypothetical scenario. If so, you’d need to have the physical asset in your possession. A gold ETF would be of no use, nor would gold futures or physical gold stored in a bank vault. No, what we’re talking about here is emotional-support gold. If you choose to carve out a portion of your assets and purchase physical gold, be aware that there is an opportunity cost to this. You’re opting not to invest in assets that can generate cash flows and build wealth over time.
