Jane M. Young CFP, EA, CDFA
I have frequently been asked about the wisdom of investing in gold to hedge against inflation. Generally gold is not a great investment, it is commonly thought of as a doomsday investment. Gold is very risky and exceptionally volatile. The value of gold is based on what people are willing to pay. The market value of gold can be highly dependent on irrational emotions. Over long periods of time the return on gold has mirrored that of inflation resulting in a real return close to zero. The current price of gold is exceptionally high; it increased almost 60% over the three years ending in 2008. Additionally, the cost to acquire and sell gold can be prohibitive.
Recent increases in government spending make inflation a greater threat. A threat of inflation makes gold more appealing. Gold usually holds its value at times when other assets are losing their value. The demand for gold generally spikes in times of economic instability and inflation. If the government becomes unable to sell treasuries to cover significant increases in government spending it will resort to printing money. This will result in inflation. Historically, inflation has lead to higher gold prices.
If you decide to reinforce your portfolio with gold to guard against inflation or economic instability it should only represent a small percentage of your portfolio – generally 5% and no more than 15%.
Jane M. Young, CFP, EA
1. Don’t lose sight of your investment timeframe. You’ve heard it time and time again but stock is a long term investment. So, don’t let the current drop in the stock market cause you to make drastic changes to money you won’t need for 10, 15 or 20 years. If you don’t need your money for 5 to 10 years stop worrying about it, the market will recover. If you are in or approaching retirement, you should have put aside the money you will need in the short term. Use this for your immediate needs. Down the road in 5 or 10 years when you need to tap into your stock mutual funds they should be back to reasonable levels. Don’t lose sleep about the level of your investments 10 years from now.
2. Every financial crisis feels like the end of the world while we are in it. If you were to look at the headlines during any one of the past financial downturns you couldn’t differentiate them from today. Every time we go through a financial crisis whether it’s the savings and loan crisis in the 80’s or the dot.com crisis the message is the same. This time it’s different, things will never be the same, the sky is falling and so forth. Everything isn’t rosy, but we will recover from this. We need to avoid making decisions based on emotion and fear. The media is in the business to sell papers or increase viewers. They are going to sensationalize our economic situation. Good news does not provide high ratings. Take a deep breath, hug your kids, walk your dog, live your life and stay the course with your portfolio – this too shall pass.
3. Don’t pass up a once in a lifetime opportunity to invest in stock at exceptionally low values. Sure it has been exceptionally painful to watch the stock portion of our portfolios drop by 40% but what a great opportunity we have. If you have a long time horizon now is a great time to invest in the stock market. I encourage you to invest a set amount of money into a diversified set of stock mutual funds every month (dollar cost averaging). Investing in your company 401k or a Roth IRA is a great way to make systematic investments. Now is the time to invest, not to sit on the sidelines. It is always darkest before the dawn. Remember, the stock market is counterintuitive – you feel like selling when you should be buying and you feel like buying when you should be selling. Therefore, right now we should be buying!!! When you feel it is safe to buy again it will be too late.
4. Choose your battles and focus on what you can control. You can’t control the fluctuations in the stock market or where the market is headed. However, you can better prepare yourself for a weak economy. Maybe now is the time to cut your personal spending and build up your emergency fund. Evaluate how to reduce your expenses and pay off debt. Make sure your skills are current and relevant. Build and strengthen your network now before you really need it. If you are approaching retirement, and the market has set you back, evaluate alternatives and contingency plans. Take advantage of opportunities available to you – buy stock mutual funds at low values, re-finance your home at a low interest rate, convert your traditional IRA to a Roth and sell those especially weak stocks to harvest tax losses.