Golden Opportunities for Investing?

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Gold: Better for the jewelry box or the Olympics.

As Valentine’s Day nears, it seems like as good a time as any to cover the frequently asked question about whether gold has an appropriate place in your investment portfolio. We’ve got nothing against your considering the tasteful gift of gold for your sweetheart this time of year, but when it comes to your or your loved ones’ life savings, we advise you to avoid all that glitters.

In his article, “Gold Bugs Swatted Again,” Rick Ferri does a good job of explaining why we feel this way:

“Gold has never been on my buy list because I’m a cash-flow and real-return investor. I like investments that pay dividends or interest, and those that grow in value over the inflation rate. Gold doesn’t fit into either of these categories. A bar of gold produces no income and never grows into two bars of gold. In fact, it costs money to own gold due to trading cost, storage costs, insurance and possibly management fees.”

This speaks to the heart of how capital markets deliver wealth. As a distinct asset class, gold reminds us of the Sesame Street lyrics, “One of these things is not like the others.”

Golden Investment Opportunities
To build wealth, you are obligated to expose yourself to market risk. No play, no pay. But investing is about tightly managing the market risks you must accept to achieve your financial goals, based on a rational analysis of their expected rewards. This means it’s imperative to have at least some understanding of how those market risks are expected to “work” under various market conditions.

Gold doesn’t play well under these conditions. In a Dimensional Fund Advisors paper we shared last year, “You Have To Be in Gold,” Weston Wellington comments, “Some might argue that gold’s price behavior will never succumb to rational analysis.”

In a more recent article, “The Golden Ticket Trap,” Jim Parker of Dimensional adds, “[Gold] sells because it plays to a misconception about how markets work: that they are like beaches after a hot day, full of buried treasures. All you need, in this view of investing, is a virtual metal detector to find the money that people left behind.”

In addition to gold pricing defying rational planning, there’s also good evidence that the long-term returns are underwhelming. In yet another Dimensional article, “Is Gold Worth Its Weight in a Portfolio?” Bryan Davis observed, “From a long-term perspective, gold has not experienced a reliable or sustained rise in value. In fact, its price appreciation has been limited to unpredictable, isolated episodes of high demand. Investors who attempted to time these episodes exposed their wealth to potentially higher risk and to the opportunity cost of missing out on stock market growth.”

Gold Is a Gamble
Speculating, in contrast to investing, is about placing bets and hoping they pay off, even if the odds are against you or are unknown. It’s about playing with Lady Luck. Given the extensive evidence that there is little or no logic, substance or long-term expected reward behind gold’s pricing, when you prospect in it, you’re speculating.

Bottom line, if you head to the casinos, you may get lucky and win some lucre, or you may spend your entire stake and go home empty-handed. That’s okay if you view it as entertainment and can afford to lose. When it comes to purchasing gold, we continue to recommend you limit it to the kind that comes in a small, velvet box.

Sage Serendipity: Speaking of Dimensional Fund Advisors, we enjoyed this recent CNBC interview with founder, chairman and co-CEO David Booth, with additional advice from Nobel-prize winning academicians about how to make the markets work for you. Invest five minutes to view it!