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Gold - how much is too much?

If you really want to invest in gold, pure investment options like Gold ETFs (exchange-traded funds) and Gold Bonds are available. The question is, whether you should and how much?

Gold prices have rallied 45% in the last year. This is good news for Indian households, given that global demand for gold is among the highest in India. 

However, gold jewellery isn’t really an investment, if that is what you are relying on. Firstly, there will always be a lot of reluctance to sell, secondly, the value you get on resale may not match what you paid for it thanks to making charges which get added at the time of the original sale. 

If you really want to invest in gold, pure investment options like Gold ETFs (exchange-traded funds) and Gold Bonds are available. The question is, whether you should and how much?

Gold for safe and stable returns?

Intuitively we know that gold is a ‘safe’ asset. But what does this mean? Indians have been buying gold in some form or the other for decades and because it’s never really sold and you can get a loan against this asset, the faith in gold as a safe and stable asset is unrivalled. 

In reality, however, returns from this asset haven’t been linear or upward-trending at all times. There have been long periods of flat to negative returns too. The most recent is the 7-year stretch just prior to the current rally, from mid-2012 to mid-2019. In this period, gold prices remained subdued and disappointed investors. 

However, it’s not without reason that gold is considered a safe haven. Firstly, its limited supply keeps a floor on how much prices can fall and secondly, its price has historically risen in times of economic crisis.

Gold is one of the rare assets which is sold and stored in near pure physical form and with a limited supply, the downside in value is limited. When compared with paper value of money, which can get diluted thanks to more printing of currency not backed by the actual production of goods and services, gold shows up as a better store of value and safeguard against currency inflation. 

There are two factors to consider; firstly, other than price rise there is no source of return like interest or dividend that you get from holding gold assets and secondly, its value is not predictable in short periods of time. 

This is the reason it’s thought of as stable in the long run. Its long-term return profile is one which has historically beaten annual currency inflation in an economy. Again, this does not happen every year, rather you have to hold on to gold for a decade or two, to see this kind of inflation plus return trend. 

How much should you allocate?

There are two factors to consider; firstly, other than price rise there is no source of return like interest or dividend that you get from holding gold assets and secondly, its value is not predictable in short periods of time. This makes it an unreliable choice for short term parking of money with the purpose of safe or stable returns. If you want safety in short term returns, then the flexibility and low risk of liquid funds is better than gold ETFs. 

Gold thus, can form a part of your long-term allocation and that too given the lack of fundamental drivers – other than supply – you can limit allocation to 10%-15% of your portfolio. This will be the cushion you need from long term inflation and it will help your portfolio returns in times of crisis. 

Don’t substitute gold for low-risk assets or even for long term growth assets like equity. It is strictly, a long term inflation hedge and should play only that role in your long term asset allocation. 

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