Investors piled into gold during much of the last decade, causing the price of gold to leap from $350 per ounce in 2003 to a record of $1,900 in 2011.1 Just as quickly, the rally turned into a rout. Gold lost more than a third of its value, falling to $1,250 per ounce by July 2013.
Gold’s steep rise and fall highlight its volatility and underscores the risk of holding too much of the precious metal in your portfolio. “Investors often see gold as a hedge in times of uncertainty,” says Terrence Odean, a professor of finance at the Haas School of Business at the University of California, Berkeley. “In the wake of widespread fear around the financial crisis, the price of gold was driven up. But as the market starts to revive, we’re seeing the price drop again.”
The ups and downs of gold
Investors typically use gold as protection against financial calamities. They figure the shiny metal will hold its value through economic crises, wars, hyperinflation and other worst-case scenarios. As a result, the price of gold tends to jump when investors are worried.
Investors had plenty to worry about between 2008 and 2011, as events in the U.S., Europe and elsewhere threatened the global financial system. Some investors were especially concerned about the U.S. Federal Reserve’s policy of printing huge sums of money to stimulate the economy, worried that this could lead to a weaker dollar and high inflation.
So far the pessimists’ projections haven’t panned out. The economy, while still weak, has gotten healthier, inflation has remained low and the stock market has posted strong gains. “People started putting their money back into the stock market, and they stopped buying gold,” Odean says.
Investing a small portion of your portfolio into gold may help hedge against long-term financial declines. But the price of gold can also underperform stocks and bonds for decades at a stretch. As a result, using it as a core part of your long-term savings can be dangerous.
Instead, consider holding a diversified mix of stock and bond funds, with the proportion of each type of asset determined by your time horizon and personal tolerance for investment risk. A financial advisor can help you build and maintain a portfolio that’s appropriate for you.
Such a portfolio may even provide a degree of exposure to gold through stocks in gold mining companies, which tend to rise and fall along with the price of gold—giving you some of the benefits of owning gold directly. “A diversified portfolio is the best way for most investors to work toward their goals,” says Odean. “And it means you won’t overexpose yourself to the idiosyncratic risks of one commodity.”
1 Gold-US Dollar Exchange Rate, bloomberg.com.
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