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What Percentage of Investment Should Be in Gold?

When it comes to portfolio allocation gold can be a stabilizing asset to own. But just how much should you allocate to gold? 5%, 10%, or perhaps even 20%? I did the research and here is what I found:

Allocating up to 20% of your portfolio value to gold would have yielded the highest CAGR (compound annual growth rate) over the past 50 years: 10.73%. The portfolios with a 10% and 5% gold exposure did slightly worse at 10.67% and 10.60% CAGR respectively.

Does this mean that you should just buy as much gold as possible and even an allocation of higher than 20% could be reasonably justified? In this article, we’ll look at what percentage is the right one for you and why it may be wise to keep that percentage even lower than indicated despite the better historical performance.

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How much of your portfolio should be allocated to gold?

To clarify the paragraph above, I’ve run a series of portfolio backtests with PortfolioVisualizer and compared the different gold percentage allocations – paired with the total U.S. stock market. Here’s the chart that shows each portfolio’s performance from 1971 up until today:

A true difference in performance only becomes visible when you zoom in at the beginning of the chart, i.e. in the era from 1975 up until about 1990. Here the 20% gold allocation would have outperformed the lesser allocations by a much greater margin.

However, since the enormous stock market rally in the 2000s and 2010s the other portfolios have quickly caught up in terms of overall returns. For comparison, here is a chart of the annual returns of each portfolio:

You will notice that the gold bars which represent the 20% allocation surpass the other ones, especially in the earlier periods but tend to lag behind in the later ones. What is also striking is that in years with negative returns a higher gold allocation has almost always mitigated the downturn risk. The only notable exception is in 1981.

Ok, so gold works as a hedge against economic uncertainty and financial instability. We kind of already knew this intuitively. But what does all of this data now indicate for our portfolio allocations?

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Is it better to invest in gold or stocks?

In order to better understand what percentage of our portfolio might be in gold, we have to look at the alternative assets we can invest in. Stocks are the natural counterpart.

So, why is it not better to just own 100% in gold and no stocks at all? After all the historical returns seem to indicate that portfolios with a higher gold allocation would have outperformed those with a lower one.

For this comparison’s sake, the main difference between investing in gold and investing in stocks is the asset class they belong to. Stocks are a productive investment asset, while gold is a speculative instrument. While you may have heard this before it is important to remember that gold is a non-productive asset and only provides returns once it is sold.

You are essentially placing a bet when buying gold that you will be able to sell it at a higher price to someone else in the future. With stocks on the other hand you may be content with owning them for a lifetime and never selling them as they provide a constant stream of dividend returns.

But let’s look at some of the legitimate ways you may want to use in your investment portfolio!

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How to use gold in an investment portfolio

A simple way to use gold for investment purposes is to always buy into the weakness and sell into the strength. This can be most effectively done by rebalancing. Once gold has dropped or risen beyond your desired allocation you can simply rebalance your entire portfolio and use the gold price as a stabilizing mechanism.

Let’s say you invest $10,000 in stocks and $1,000 in gold (a 10% allocation) and after a year the price of gold has doubled. Your portfolio now consists of $10,000 in stocks and $2,000 in gold (20% gold allocation).

To lessen the overall diversification risk and sell into the strength you simply rebalance your portfolio so that gold will make up 10% of total value again. Thus, after rebalancing your portfolio would like this: $10,800 in stocks and $1,200 in gold.

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Why some allocation to gold might be useful

One of the best ways to look at a gold purchase is to view it as an insurance policy. In a way, by owning gold you are insuring your securities against a collapse in the financial system. You are backing your paper shares with hard assets.

In fact, even veteran investors such as Kevin O’Leary keep a 5% gold stake in their investment portfolio and use it to counteract stock market moves. In this way, gold can fulfill its function – sound money – while also stabilizing your portfolio growth at the same time.


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