Yellow fervour: How much should you invest in gold for a solid, long-term portfolio

It is because when one suggests investing in gold to new investors (who started investing in the last 10 years), their first reaction would be something like, ‘Why should I invest in gold when equity can 'surely’ give great returns?’

To be fair, equity, as an asset class, has done phenomenally well in the last decade. Hence, people have gradually built up expectations accordingly.

But if we were to zoom out a bit and look at a longer time of history, it is evident that equity can be quite a volatile asset. And this (though not realised now), will make it very uncomfortable for new investors who don’t know much about market history.

For this reason and to build a robust, multi-asset diversified portfolio, there is a case to invest in gold.

Also read | Silver shines: Should investors keep riding this rally?

What influences gold prices?

So, what factors tend to influence gold prices?

There are many. Gold is different from other assets. It cannot be valued on the basis of cashflows or intrinsic value. Generally, gold prices are dependent on demand-supply equation and factors like geopolitical events,  global economy, etc. that impact demand-supply equation.

If you look at price history, you will notice that gold prices tend to stay dormant for extended periods of time, and such no-action periods are followed by a sudden and volatile spurt in prices which push up the average long-term return figures to historical averages.

Historically, too, gold has proven to be a good hedge against inflation. In the 1970s, when there was a high worldwide inflation, gold served beautifully as an inflation hedge. Also, there is generally a low correlation between gold and other asset classes like equities, which helps its case as a portfolio diversifier.

Also read | Gold or fixed income: which is better to help diversify your portfolio?

How much to allocate to gold?

So now, let’s try to answer this question .

If you have a small portfolio (or if you have just started investing), you should focus on equity and debt . You need to worry about whether you need gold in the long-term portfolio or not only after some time.

For others who have been already investing for a few years or already have a comparatively large portfolio, there is a need to give more importance to gold than what is generally given.

Irrespective of its importance, I prefer to treat gold as a diversifier and a natural hedge in the portfolio, and not as a core asset, like equity or debt. That said, in my view, one can consider having a 5-15 percent allocation to precious metals, especially gold, in the portfolio. And while 5 percent or lower may be too small to have any material impact on the overall returns or risk, it shouldn’t have more than 15 percent allocation.

There is a growing view among many large investors nowadays that precious metals will do very well in the commodity cycle that seems to be taking an upward trajectory.

If that happens, of course, gold investors will do well. But to be fair and as a disclaimer, no one can predict such things. So, this discussion should be seen as a view on the role of gold as a portfolio diversifier and not as a return enhancer, in case the commodity cycle plays out.

Also read | Bonds, equities or gold? Which is the best asset class while RBI makes up its mind on interest rates?

How should you go about building gold allocation?

If you don’t have any material allocation to gold, don’t go overboard and buy 5-10 percent in one go. Try to gradually scale up your allocation to gold -- first to 5 percent in small tranches. Once that level is achieved, consider whether you require a further increase to 10 percent or not. A good investment advisor can help you understand how and when this should be done.

So, for a 45/50-year-old who has no allocation to gold, he/she can first try and scale up the allocation to 5 percent in the next 1-2 years. After that, scale it up to at least 10 percent (or if need be, 15 percent)  till retirement.

No matter what the recent returns are, don’t get influenced by short-term price moves. Always, let your (chosen) asset allocation strategy decide how much to invest in gold at any given point in time. Don’t act randomly based on tips from your friends or social media influencers.

Disclaimer: The above discussion should not be considered as investment advice by anyone. Everybody’s financial goals and requirements are unique. So please talk to your investment advisor to know whether and how much should you be investing in gold.