Here is how to think about gold in your investment portfolio

Gold prices are at record highs leaving many investors wondering what role it should play in their portfolio.

As with any investment, it’s important to understand what you are buying. Riding a trend or investing in something just because other people are isn’t a strategy.

Don’t get me wrong. Gold is a vital asset class. Depending on your risk tolerance, gold could make up between 2-5% of your overall portfolio.

But I remember when gold prices last experienced a noticeable surge – during the first few years after the 2008-2009 financial crisis. During that time, I would meet with prospective clients who requested portfolios with more than 50% in gold and silver. That’s ludicrous!

People put too many chips in that basket back in the years after the financial crisis and I don’t want people to make the same mistake this time around when gold seems to be back in favor.

What Gold does for Your Portfolio

Before you invest in gold, it’s important to understand what the asset can do for your portfolio. There are a few use cases for gold as an investment.

It works well as an inflation hedge. Inflation is when prices rise giving you the consumer less purchasing power. It’s probably realistic to expect inflation at some point down the road given our large deficit, the expansion of the Federal Reserve’s balance sheet to $7 trillion from $4 trillion this year and with more fiscal stimulus expected from Congress to fight the economic fallout of COVID-19.

Gold also works well during times of deflation. Many people aren’t aware of this. That’s when prices fall. Remember when the first plasma TV was $5,000 and then a few years later it sold for $1,500? That’s deflation.

A lot of people expect this COVID-19 crisis to be deflationary in the short-term, but inflationary over the long-term.

Bottom line: gold tends to outperform when there is volatility in the expected rate of inflation. If inflation rises by 2%, but veers off course and ends up rising 4% instead, that tends to be good for gold prices.

The other use case for gold in your portfolio is as a calamity hedge. We see gold prices rise during times of stress: the 2008 financial crisis, an unexpected crisis like COVID-19 and when trade tensions between the U.S. and China escalate.

How to invest in gold

There are also multiple ways to invest in gold. You can buy an exchange-traded fund that tracks the price of gold. The SPDR Gold Trust ETF (ticker: GLD) is how many people invest in gold.

You can also buy the stocks of gold mining companies. Doing this helps to sensationalize the returns, compared to just buying an exchange-traded fund that simply tracks the price of gold. Buying the gold mining stocks may result in more volatility. When the going is good, your returns might be way better — and when times are tough, the returns may be extra worse.

Another alternative is to purchase physical gold. I think it makes sense for people to have some gold and silver coins – but remember, within reason.

Outlook for gold prices

Gold prices are in a positive uptrend. But I wouldn’t be buying gold at record prices. I would instead be adding to my gold position on pullbacks. You have to be strategic.
You don’t want to buy gold on a day when it’s up 2%. Wait for a pullback. Just because gold prices are at record highs, doesn’t mean you need to jump on the gold bandwagon right away.

About the Author:

Mark Tepper, CFP

Mark Tepper is President and CEO of Strategic Wealth Partners, a wealth management firm based in Independence, Ohio, and host of The Capitalist Investor podcast. Follow him on Twitter @MarkTepperSWP.

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