After the stock market crash of 1929 and again in 2008, investors learned the importance of diversifying their portfolios. Diversification reduces risk by allocating your money across different types of investments instead of keeping it all in one basket.
Investments that tend to move in opposite directions at the same time are known as “corresponding” or “neutral” assets. They are not perfect substitutes, but can be used to balance out a portfolio when one asset class is overheated and another is undervalued. A well-balanced retirement portfolio for example will include stocks, bonds, real estate, and perhaps even something like gold as a hedge against inflation or other unexpected events. The following article explores why you might consider adding gold to your diversified investment portfolio.
What is Diversification?
Put simply, diversification is the process of dividing your assets among different types of investments so that one bad investment doesn’t ruin your financial future. While it doesn’t guarantee a profit or protect against loss, it does reduce overall risk and can be an important part of an investor’s strategy.
The fact that most investments are cyclical and sometimes experience dramatic ups and downs means that placing all of your money in one asset class can be risky. Diversification can help reduce the risk of a pension portfolio that is heavily weighted in one type of investment by increasing investor exposure to other investment types. There is no guarantee that any particular investment will perform well over time, but diversification can help reduce the impact of a poor performing asset on a portfolio’s overall performance. Investors who diversify can expect lower returns than those who invest heavily in just one asset class, but they can also expect to experience less volatility.
How is Gold a Good Diversification Investment?
Investors have used gold as a diversification tool for centuries because it tends to be negatively correlated with stocks. In other words, when stocks are doing well, gold tends to be doing poorly, and vice versa. There are a number of reasons for this. First, gold is a tangible asset that can be held in the physical form (such as coins and bars) or in the form of certificates or coins. Alternatively, it can be held in the form of gold funds, which are traded on the stock market. There is also a correlation between gold and inflation. If inflation rises, the demand for gold tends to increase. This is because gold is often considered a store of value in times of economic stress due to its relative permanence compared to other assets such as stocks.
How to Buy Gold as an Investment?
There are two main ways to invest in gold – physical gold or gold funds. Physical gold includes bars, coins, and jewelry. Physical gold can be sold at the spot market price, but it has to be melted down and verified. You can store the gold at home, in a depository or as part of a gold backed IRA. Gold funds are traded on the stock market and are priced according to the value of the gold held by the fund. Keep in mind that you may be subject to some fees when investing in gold. Also, when you sell your gold, you will receive the spot price at the time of the sale, and not necessarily the price you paid when you bought it.
Drawbacks to Investing in Gold
Gold is not a guaranteed investment: While gold has been considered a relatively safe investment over the long term, it is not without risk. As an example, gold prices dropped sharply during the financial crisis of 2008 and only started trending upward again in early 2009. It is also not liquid: Unlike other investments, such as stocks and bonds, gold is not often traded on the open market. This means it can be difficult to sell in large quantities when needed.
Bottom line
Some investors view gold as a safe haven, while others view it as a protection against inflation. While it can be a great diversification tool in portfolio management, it is important to understand that gold is not risk-free. Though it has been considered a relatively safe investment over the long term, it can be impacted by a number of factors, including geopolitical events and changes in monetary policies. The price of gold is driven by supply and demand, so when demand is high, the price of gold tends to increase. Investors who want to diversify their pension portfolios and hedge against risk may want to consider investing in gold.