American Century Investments released a good note on the role of gold in a diversified portfolio. As an uncorrelated asset class gold can play a valuable role in a portfolio, however, as a volatile asset class it must also be properly managed so as to avoid excessively high allocation and portfolio risk due to specific position risk. On the whole though, gold can play a valuable role in a diversified portfolio for both young and old investors. American Century elaborates:
“Gold’s Role in a Diversified Portfolio
The key consideration for gold investors is not so much the price of the metal, but what is gold’s role and allocation in your overall portfolio. Because gold benefits from safe-haven demand in times of political and economic uncertainty, and it has unique properties as an alternative currency, the precious metal has a low correlation to the performance of stocks and bonds. That is, gold has tended to do well when stocks and bonds struggle, and vice versa. These characteristics mean gold is well suited to diversify a larger portfolio against inflation or market uncertainty.
From a short-term, market-timing perspective, it’s hard to advocate buying gold—or any other asset, for that matter—after a huge run-up. But from a long-term, portfolio diversification point of view, it can make sense to have an allocation to gold because it tends to do well when other asset classes struggle. Of course, diversification does not ensure a profit or protect against a loss in a declining market.
For younger investors/those in the wealth accumulation phase: It’s important to remember why you are investing in gold—it’s meant to be a small allocation in a much larger, diversified portfolio, not a core portfolio holding. For this reason, a number of analysts suggest that a modest 3–5% allocation to gold or gold stocks could be a hedge against a downturn in financial markets related to inflation risk or other economic or political uncertainty.
For older investors/those in the wealth preservation phase: Here, too, investors must consider the high degree of volatility and risk inherent in gold investing, and allocate only a comparatively modest portion of their overall portfolio to gold. Analysts typically suggest a 5–10% allocation to gold may be appropriate for investors in the wealth preservation phase of their financial lives. This higher allocation is because you are more vulnerable to the effects of inflation (or a market sell-off as a result of financial uncertainty or calamity) the closer you are to retirement—your balance is at its highest level, and you won’t be making any more contributions to offset losses.”
Source: American Century Investments
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.