When clients want to load up on gold, financial advisers need to stress to them that overweighting the precious metal can actually weigh down their portfolios.
People tend to buy gold when they question the value of paper currency, either through inflation or currency devaluation. In times of true catastrophe, such as hyperinflation or government collapse, gold can maintain purchasing power. And it's relatively portable, in case you need to hotfoot it out of the country.
Gold in relatively small amounts can have a place in a client's portfolio to dampen volatility in a stock-heavy portfolio.
“As a rule, we have 8-10% in commodities (including metals, raw materials, water, etc.) and managed futures since they tend to be negatively correlated or non-correlated to U.S. and foreign stocks,” said Mark Bass, a certified financial planner in Lubbock, Texas.
FEAR OF COLLAPSE
But some clients want to have large amounts of gold in their portfolio, either because they fear impending financial collapse or paper money in general. “The clients that have more than 8%-10% are either preppers, or think the financial markets are at greater risk of decline, or come by it through business experience — such as my clients that own a jewelry store,” Mr. Bass said.
The problems of too much gold in a portfolio are manifold. A large gold position can add volatility to a portfolio, rather than reduce it.
Despite its 16.2% rally this year, gold is still down about 35% since its September 2011 high of $1,895 an ounce.
Read more: How much gold can you legally own?
“While gold is often thought of as the ultimate investment that survives all of man's follies, it has clearly not been a good investment during our lifetime,” says Ray Ferrara, a certified financial planner in Clearwater, Fla. “Over the past 45 years, it has provided an average annual return of 8.2% with a lot of volatility. If you measure it from 1980, it has risen at an average annual rate of 1.2% — is that really what you want from a long-term investment?”
Gold also offers some additional problems. Many investors find that buying gold through commodity funds, such as the SPDR Gold Shares ETF (GLD), is a simple way to get exposure to gold without worrying about how to store it. “We don't routinely use gold, but when we do, we use an ETF,” Mr. Ferrara said.
ETFs overcome one major problem: storage. True, you can put gold coins in a safety deposit box. But those who really like gold often fear an imminent societal collapse. If so, an ETF or a bank safety deposit box won't appeal to them, because they imagine banks being closed and financial institutions collapsing during those periods. And as an adviser, you probably don't want your client burying half his portfolio in the back yard, or being responsible for a treasure map.
MORE GOLD, MORE TAXES
In addition to storage, there's taxes. Gains on gold are taxed at 28%, the same rate as collectibles. The same rate applies to ETFs that invest directly in the metal. In contrast, the maximum long-term capital gains rate on stocks is 20%. And gold pays no dividends. Its price is derived entirely by fear, supply and demand.
And worries about supply and demand have always been a problem with gold. In 1857, the SS Central America sank off Cape Hatteras, taking some 30,000 pounds of gold for more than 100 years' safekeeping in Davy Jones' locker. The shock to the nation's money supply — the U.S. was on the gold standard then — led, in part, to the Panic of 1857.
While no country is currently on the gold standard today — there really isn't enough of the stuff to create a reasonable money supply for a global economy of 7 billion souls — supply and demand fears haunt the gold market today, and add to its volatility. The world's top gold producers include China, Russia, Uzbekistan and South Africa, none of which are exactly models of stability at the moment. (To be fair, Australia, the U.S. and Canada are among the top 10 gold-producing countries in the world).
If you're not worried about other countries' mining gold, you can legitimately worry about other countries hoarding or selling gold. (Back in the days when the U.S. was on the gold standard, the Treasury would sometimes buy and sell gold on the open market to stabilize the sometimes frenzied speculation in the metal). The U.S. holds 8,133.5 tons of gold, according to the World Gold Council, followed by Germany, which has 3,381 tons. In theory, either country could sell part of its reserves to pay down its debt.
Is the yellow metal worth its volatility? In small amounts, possibly. “Nothing wrong with owning a few gold coins in case the world comes to an end,” Mr. Ferrara said. “As for an investment or a hedge against inflation, there are much better places for an investors' money in the long term. If you must own gold for some reason, having more than 5% in your portfolio will likely cause the portfolio to underperform.”
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