Whenever the market experiences significant volatility you're likely to see "gold bugs" swarming your social media and cable news feeds. Investing in a commodity like gold that we perceive as "stable" sounds appealing when other investments, like stocks, seem unstable. And it's true that the price of gold has risen in 2020 as the economy continues to adjust to Covid-19.
But as we discuss on today's podcast, adding gold to your portfolio is not a surefire way to mitigate risk. And folks who move their assets out of the markets in order to buy gold could be making a long-term mistake.
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1. A brief history of the gold standard.
Gold has been central to economics since the ancient Romans, who set the value of their coins against a pound of gold. Essentially, this idea of a "gold standard" backing fiat currency continued right on through to modern times. Then, in 1971, President Nixon announced that the U.S. would no longer use gold reserves to back the value of the U.S. dollar. This change transformed gold into its own commodity whose price depended on supply and demand. And since the dollar was no longer tied to a fixed asset, the U.S. had new tools like adjustable interest rates it could use to tweak our economy as needed.
2. The pros and cons of gold.
Economists and financial professionals still debate the pros and cons of moving off the gold standard. Some experts believe that our economy was more stable and less burdened with debt when gold was backing the dollar.
But when the amount of money in an economy is fixed to one asset, you can't print more to stimulate the economy. If we were still on the gold standard, our government would have had to buy more gold in April in order to finance the CARES Act and other relief efforts that helped to stabilize our economy after Covid-19 hit. Data also suggests that we have a better handle on things like inflation now than we did during the gold standard days, in part because we have more tools to fight it.
3. Why gold and why now?
So why do people get interested in gold? I think there are three main reasons:
- To hedge against inflation. It's true that during the economic crises of the 1970s, the price of gold rose with inflation. But, in the 1980s and 1990s, inflation went up and the price of gold dropped.
- To hedge against a weak dollar and rising government debt. Probably the biggest reason that gold has skyrocketed this year is that short-term deficit spending has had an impact on the value of the dollar. Investors who worry about the sustainability of our national debt see gold as a safer play than the markets. However, the value of our currency depends on several factors, including interest rates, productivity, and economic growth, all of which should start increasing again as we learn how to work more effectively during the pandemic. And again, if the government didn't have the ability to take on debt when it needs to, it wouldn't have been able to stabilize things a bit in April with the CARES Act, small business loans, and other programs.
- Fear. Add up all these factors that we've been talking about and you get an economic environment that's very scary to a lot of folks. And understandably so! Nothing riles the markets more than uncertainty, and we have plenty of it right now in America. We don't know if we'll have a Covid-19 vaccine before the end of the year. We don't know what "the new normal" is going to look like once we get the virus under control. We don't know what our government is going to look like after the election in November. We don't know if millions of unemployed people will return to their old jobs or how many of those jobs are gone forever.
4. Take "The Oracle's" perspective.
Here's what we do know.
First, if you look at indexes that measure long-term volatility over time, gold just isn't as stable as gold bugs would have you believe. Gold markets have peaks and valleys just like any other investment, but those valleys tend to last longer, especially once the economy starts to pick up.
Second, and perhaps most importantly, gold does not outperform the markets in the long run. "The Oracle of Omaha," Warren Buffet, laid this out very clearly in his 2019 letter to Berkshire Hathaway Shareholders:
"Those who regularly preach doom because of government budget deficits (as I regularly did myself for many years) might note that our country's national debt has increased roughly 400-fold during the last of my 77-year periods. That's 40,000%!
Suppose you had foreseen this increase and panicked at the prospect of runaway deficits and a worthless currency. To 'protect' yourself, you might have eschewed stocks and opted instead to buy gold with your $114.75. ($114.75 is what Buffet paid for the first stocks he ever bought when he was 11!)
And what would that supposed protection have delivered? You would now have an asset worth about $4,200, less than 1% of what would have been realized from a simple unmanaged investment in American business. The magical metal was no match for the American mettle."
Crunch the numbers and that same $114.75, invested in the S&P 500 index, would be worth over $600,000 today. Ultimately, the issue of buying gold circles back to that all-important question of "Why?" If you're looking to diversify your portfolio for the long haul, commodities are certainly an option we can discuss. But the road that runs between where you are today and where you want to be in the future isn’t paved with gold or any other cure-all. It’s paved through diligent planning, committed saving and investing, and a clear vision of what you want your retirement destination to look like.
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Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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