India’s love for gold is not just because it has a great social and cultural significance; it is also because people consider it as a ‘safe’ investment option. Unlike currency and other tangible and intangible assets, the metal has held its value through centuries. Therefore, many Indians see gold as a way to preserve their wealth, which can be passed on to future generations on their wedding or during festivals and other celebratory occasions like Diwali and Akshaya Tritiya. However, there are many people who think that gold must not be part of an investor’s investment portfolio as it does not yield high returns. Gold might not be an ideal investment option but it protects investors against various market uncertainties. There are various other points discussed in this post that elaborate on why gold must be a part of your investment portfolio.
1. Plays an important role in asset allocation process
Gold plays an important role in the asset allocation process. The objective of asset allocation is to diversify your investment, i.e., to distribute your investments across different asset classes, such as debt instruments, derivatives, equity and gold, to get optimum returns at the lowest possible risk. In all of this, gold is used more as a hedging instrument rather than an investment instrument. When asset classes like debt instruments, currency and equity become risky to invest or hold, gold is used as a ‘safe heaven’ by investors, banks and other financial institutions alike to reduce the risk in your overall portfolio and fetch higher returns.
2. Acts as a hedge against inflation
Gold rates tend to rise with the increase in the cost of living. If we look at the gold rate movement in the past 50 years, you will notice that the prices have soared while the stocks have plunged during high inflation years. This is because when the inflation rate increases, the value of the currency dips. As compared to gold, almost all major currencies in the world have depreciated in value. This is why people hold money in the form of gold.
3. Helps in dealing with financial emergencies
When you face a financial emergency, you need something that can get you cash as quickly as possible. Since your bank account balance may not be enough to deal with the situation, you look for other alternative options. In such a situation, especially when you are not qualified for personal loan, physical gold fits better than any other physical asset such as property. The metal can be bought, sold and pledged much faster than many other physical assets. And because of this feature, one can easily take gold loan at attractive interest rates from banks and NBFCs and overcome the financial crisis.
If we take gold investments into consideration then unlike other asset classes, these too (except Sovereign Gold Bonds) are easy to redeem as it does not include a lock-in period. This is also why many investors use the yellow metal when an urgent financial situation arises. And not just people, countries too use gold to get out of financial crisis. For instance, in 1990’s, India had pledged 46.1t of gold to International Monetary Fund (IMF) in order to raise $400 million to cover balance of payment debts.
Before liquidating your accumulated gold remember that the redemption amount in the case of physical gold depends on its purity, denomination, market price, etc. And in case of paper gold such as gold ETFs, the gold price at the day of redemption will determine the amount you will get on your investment.
4. Acts as a hedge against geopolitical crisis
Geopolitical turmoil and uncertainties usually have a negative impact on the most asset classes. But this is not how gold works. When global tension rises, investors run towards gold to park their funds. This in turn increases gold’s demand in the market and resultantly its rates. This is how the metal retains its value during such situations. For instance, gold rates experienced some significant movements this year in response to the crisis over Korea’s nuclear capability. Besides, geopolitical crisis, gold rates also rise when people’s confidence in their government is low.
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The reasons listed above are why every investor must include gold in his/her investment portfolio. Making it a part of your asset allocation will help you reduce the risk to your overall portfolio from political and economic uncertainties. Keeping your risk appetite and financial goals in mind, you can hold about 5% to 20% of your portfolio in gold or gold-related securities.