The question I get asked most often is should I buy gold?
My answer? You are asking the wrong question.
Investors buy and sell gold at the wrong times.
If you are talking about making a short-term profit by buying gold and then selling it at a higher price, the issue is very simple. You are speculating and not investing. You could be right or wrong, but the risk is high.
Investors tend to buy and sell at the wrong times, driven by emotion and incompetent advice from “financial professionals.” Burton Malkiel, the author of A Random Walk Down Wall Street, recently noted in an article in the Journal of Indexes that investors follow the disturbing pattern of investing right before a crash and withdrawing money right before a recovery.
Malkiel also made the surprising observation that institutional investors fall into the same pattern. Their market-timing skills are no better than those of the amateur investor.
When you speculate in gold, you believe the price of gold will increase in value due to market forces. The “father of financial mathematics,” Louis Bachelier, concluded, “The mathematical expectation of the speculator is zero.”
Gold is not a good long-term investment.
If you are talking about adding gold to your portfolio and holding on to it for the long term, the analysis gets more complicated.
The long-term data indicates that gold is not a prudent investment. One study looked at gold returns over the forty-eight-year period from 1945 to 1992. Its annual return was 4.9 percent. Over the same time period, the annual return of Treasury bills was almost identical, at 4.8 percent. But here’s the one factor most investors ignore: What was the risk of each of these investments?
The risk of an investment in gold was almost nine times the risk of an investment in Treasury bills. Why would you take nine times the risk to achieve almost identical returns?
The results are even worse when you look at the thirty-five-year period from January 1974 to December 2008. Gold underperformed Treasury bills, and the risk of investing in gold during this period was more than seventeen times the risk of investing in Treasury bills!
Other studies have shown that adding commodities to a portfolio did not improve diversification and did not provide a hedge against inflation in stock-and-bond portfolios.
Beware the hype about gold
There is a lot of hype about gold. It typically dangles the prospect of astounding returns and includes a prediction of financial Armageddon. Should you pay attention?
You need to evaluate whether the people making these predictions have a conflict of interest. Are they in the business of selling gold?
Recently, the aggressive promotion of gold by Glenn Beck, the outspoken political commentator and author, came under scrutiny. It turns out Beck was a paid spokesman for a gold sales company. This is information you need to know before you whip out your wallet.
I am a big fan of John Bogle, the founder of Vanguard. Here’s what he had to say about commodities: “I, for one-I hope it’s all right for me to say this-have no conviction that commodities belong in anybody’s portfolio, at any time, under any circumstances. Did I make that clear?”
It’s clear enough for me, and I hope it’s clear enough for you!
Dan Solin is a Senior Vice-President of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You’ll Ever Read and The Smartest 401(k) Book You’ll Ever Read. His latest book is The Smartest Retirement Book You’ll Ever Read.
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