Investors aim to diversify their portfolios across multiple assets to minimize their risk and capitalize on more opportunities. Many investors prefer to stick with what they know and opt to buy stocks in their favorite companies. However, limiting yourself to what you know reflects familiarity bias. This bias is a core element of behavioral finance that can hurt an investor’s returns. Investing in assets you know without exploring new opportunities, such as gold, can hurt your portfolio’s long-term performance and leave you exposed to considerable risk.
Most investors gravitate toward stocks and ignore precious metals like gold, and the data backs this up. A study concluded that 84% of Americans do not own gold or silver. Only 6.5% of the respondents owned both gold and silver. American interest in the stock market has a much different narrative. According to a recent survey, 61% of Americans own stocks. Over 80% of households bringing in over $100,000 per year have some of their money invested in stocks.
For many investors, gold is uncharted territory, but now may be the perfect time to build a mini Fort Knox for your portfolio. These are the three pros and cons to consider before investing in gold.
Advantages
Gold has been a staple for civilizations for thousands of years. The commodity always has value as a unit of exchange due to its various capabilities. Gold has a limited supply, and like many commodities, investing in gold is a hedge against inflation. While stocks can eventually lose value due to inflation impacting future earnings, gold tends to rise as inflation heats up.
Additionally, when the stock market goes in to a downturn gold is probably flat or gaining value. The precious metal does not correlate with the stock market, and bad news for the stock market is often good news for gold. Gold can offset your stock portfolio’s losses and help you diversify your portfolio. You can buy shares of gold mining companies, but these stocks have some correlation with the rest of the market.
Lets not forget that Gold ETFs give investors exposure to gold and the ability to quickly enter and exit trades. While many of these ETFs hold onto gold mining companies and have expense ratios, they give investors an easy way to get exposure. It’s never been easier to put gold into your portfolio through one of these funds. Investors should assess fees and long-term performance before putting capital into these funds.
Disadvantages
Gold tends to go in the opposite direction as interest rates. If interest rates go up, gold usually goes down. The U.S. Federal Reserve remains committed to keep interest rates elevated for a longer period of time. This policy can limit gold’s total returns for investors. However, inflation remains the main focus and is the reason interest rates are so high. If inflation continues to get hot, it can benefit gold more than interest rate hikes hurt the commodity. When the Fed eventually lowers rates gold stands to benefit, but that could take a while.
Moreover, if you begin investing in gold, you will have to pay for storage. These annual storage fees will minimize your profits and may cost more than a fund’s expense ratio. Investors who buy physical gold get the satisfaction of owning the commodity, but you then have to have somewhere to put it.
Liquidity is a big issue for many commodities. You can’t enter and exit trades within seconds like you can with stocks. If you buy physical precious metals and store them, you can be stuck with them for quite some time. It can take a while to convert gold into cash for emergencies. Allocating funds across your portfolio so precious metals only consist of the money you don’t need for a few weeks can mitigate this risk.
On the date of publication, Marc Guberti did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
