Broadly, there are four 'asset classes' or 'investment options' which are commonly used to construct a well diversified investment portfolio. These are fixed income or debt, equity, real estate and gold. Out of these four, gold is most misunderstood and least discussed investment option.
In Indian context, gold assumes greater importance due to social and cultural reasons. For centuries gold is synonymous with wealth, status, security and protection. In traditional Indian families, gold is regularly purchased on various occasions and festivals like child birth, marriage, wedding anniversary, birth day, dhan teras, Diwali, New Year, Akshya Tritiya and list is long and endless. Also, gifting of gold within family members from mothers to daughters, from mother-in-law to daughter-in-law, from parents to children and among brothers and sisters is considered auspicious and is an integral part of festivities and celebrations. As a result, most Indian families have acquired or invested significant part of their savings in gold or gold ornaments.
Gold is an unproductive asset. Its prices are largely determined by supply of and demand for. Due to the limited supply, its prices tend to rise over the years with growth in demand. However, the million dollar question is whether investment in gold results in long term wealth creation? The answer is a disappointing “NO”.
Gold has never helped anyone become wealthier as its prices seem to rise with inflation in the economy and not any higher. If we look at long-term history of gold prices for last 50 years or so, it has at best kept pace with inflation. In other words, gold helps you protect the value of your savings and not enhance it which has to be every one's goal. Average inflation in Indian economy in post-independence era has been in the range of 8 to 10% pa and price of gold has also moved up at the same pace.
Interestingly, a research was conducted in the UK where prices of two items, namely, gold and apple were compared over a long period of five centuries i.e. 500 years. Strangely, it was concluded that one ounce of gold could be bartered with same quantity of apple in kg in the 16th century as well as in the 21st century. It was established beyond doubt that gold catches up with inflation in the economy.
In context of investments, two asset classes, namely, equity and real estate have beaten gold handsomely when it comes to wealth creation possibilities of these popular investment options. Millions of people across the globe have created substantial wealth by carefully investing their savings in equity and real estate as opposed to popular choice of gold.
It is pertinent to mention here that gold has some unique qualities. On a lighter note, it can be displayed and physically worn which can bring happiness, joy and pride to some individuals as opposed to share certificates, mutual fund statements or property ownership papers which naturally cannot be displayed or worn on a day to day basis!
Also, gold is most liquid amongst all asset classes as it can be easily exchanged with cash even on a Sunday afternoon by visiting a jewellery shop or a goldsmith who would happily accept physical gold and give cash in lieu of the same. Same is not true for financial investments or real estate investments.
We are not advocating that investment in gold should be avoided. As a thumb rule not more than 10% of your total investments should be invested in gold or gold related instruments like gold mutual fund or Gold ETF or gold bonds. Our estimate is that most families in India have enough quantity of gold and if proper computation is done, most of them will have around 10% of financial investments in gold. In case actual investment in gold is less than 10%, additional investment may be made but not in physical gold. Better option will be to invest in gold ETF or gold Bonds. Similarly, if value of gold holdings is higher than 10% of total portfolio, there is no need to sell gold in a hurry. At least do not buy any further gold unless your total portfolio improves over the years and value of gold comes to near 10% of the same.
Post demonetization in November 2017, there is a visible shift in investment pattern amongst Indians from physical investments like real estate and gold to financial investments like mutual funds and bonds. This is a very healthy phenomenon and should augur well for Indian economy in decades to come.(The writer is Group CEO & Director of Bajaj Capital)