Gold is considered valuable everywhere in the world. From kings to central banks of countries, the metal's worth has been undisputed over centuries of civilisation. Its is unique, scarce and highly liquid. It holds no liability and not tied to the economic performance of any country.
Despite the obvious reasons to buy gold, it is also important to understand that the metal is a great strategic asset among modern-day modes of investments to diversify risk. In Indian households, purchasing gold has been part of the tradition, to help families in times of economic distress.
It is also the same reason why you should rethink how you look at the precious metal a part of your investment portfolio and help you enhance risk-adjusted returns.
Balances portfolio risk
History is proof that the metal endures economic distress better than other asset classes. In fact, if you were to look at the performance of gold in the last 10 years, it has given better returns than the Indian stock market in 2010, 2011 and even 2019. The rally in gold prices was also significant in 2020, when it touched a new all-time high in India, as well as, abroad in the month of August.
This is because gold has a negative correlation to stocks. When the economic outlook appears dull (for example in 2019 due to the US-China trade war and in 2020 due to COVID-19), the precious metal gains due to its appeal as a safe-haven asset. On the other hand, with businesses poised to report a decline in earnings, investors withdraw funds from stocks.
The key to diversification is to not invest in correlated assets. For example, if you have only invested in individual stock investments and in equity-oriented mutual funds, both will fall or rise at the same time as the two kinds of investments are linked in linked to equity.
Investing only in gold also does not make sense as equity performance much better in a positive economic environment.
How much gold should you hold?
Experts suggest that investors should hold between 2 to 10 percent of their total investment portfolio in gold to improve their overall performance. Every time there is a dip in the equity markets, gold will gain and balance the losses; lowering your risks in investment.
This investment does not have to be physical gold. You can purchase gold ETFs, gold mutual funds or even digital gold; all of which are easy to sell.
Gold has been considered as an important part of a well-diversified investment portfolio because of the price of the metal increases in response to events that cause a decline in the value of paper investments, like stocks and bonds.
While gold prices may fluctuate in the short term, it will always increase in its value over the long-term because it is scarce in quantity and high in demand. Apart from making jewellery, gold is used in electronic gadgets, held by central banks (as forex reserve) and even bought heavily as gold ETFs.
It has been used as a hedge against inflation and a decline in currency valuation, which makes it an investment worth considering in the long term.