Posts tagged Gold
Why I own gold…
Feb 10th
Why do people freak out so much when you tell them you own some gold in your portfolio? It’s as if you had just told them you killed a dozen people before lunch. The hyper-ventilation you hear from some when you even mention this topic is just nutty. It usually starts with some juvenile comment involving tinfoil hats. Then they pull out some quote from an economist (usually one that loves inflation to solve all problems) about how useless gold is. They may even hit you with the ol’ “gold is not a form of wealth but just a shiny metal” lecture (ignoring the bulk of human history, and all major central banks, that disagree with them). Then they tell you how “risky” gold is when their own portfolio may be loaded to the hilt with junk bonds, emerging market debt or other complicated investment products. They must think the Nigerian stocks they hold in their Frontier Market fund are a sure thing (assuming they even know what’s in the funds they own).
Well, I own gold and I admit it. I feel comfortable owning gold in my portfolio. I sleep well at night knowing I own gold even though it could drop in value. I understand that in a balanced portfolio gold is a useful tool. I trust gold to protect me in high inflation more than indexed linked bonds (TIPS) ever will.
Gold has no interest or dividends. I admit these things and acknowledge that this is one area that makes gold different than stocks and bonds. However, this does not make gold useless for diversification.
Gold maintains real purchasing power over time and it’s really good at doing this. No other asset on this planet has such a long history. I don’t worry about politicians printing trillions of dollars of gold. This is because politicians can’t print gold. Gold can also be owned directly without any obligations attached to it. These are unique attributes for an asset class when used properly in a portfolio (and properly does not mean 100% gold).
While gold does not have the interest or dividends of stocks and bonds, it has other benefits that can work at certain times to protect a portfolio that does hold stocks and bonds. Gold for instance does very well under high inflation when stocks and bonds do not.
Gold has risks just as stocks and bonds have risks. I understand what these risks are and how they fit in a diversified portfolio. Yet, I do not rely only on gold in a portfolio. I also own stocks and bonds to drive returns when gold is performing poorly. In diversification there is safety which is why I own all these assets and don’t get religious about it. I accept gold’s quirks because I know when it comes time for it to perform it will do so better than all its contemporaries.
The empirical evidence says that owning some gold in a portfolio is not the death sentence academic literature would suggest. In fact, at certain times having gold can be a tremendous help. So, either reality is wrong or the academic theories are. Given a choice between the two, I’ll take reality. That reality is that all portfolios should hold some gold for diversification against stocks and bonds despite what critics state. That’s why I own gold.
FerFal Responds About Gold and Real Estate
Jan 21st
The previous book review of The Modern Survival Manual: Surviving the Economic Collapse covered the insider’s view of the Argentina financial crisis of 2001 and what happens when a society sees their currency lose more than 2/3rds of its value in a short period. It was an interesting read with unique insights into economics and sociology that you just won’t find in a standard textbook on the subject.
Now, I’m impartial to investment assets and don’t believe in extremes. I had some questions along the lines of going to extremes in investments and wrote to FerFal (Fernando – author of the book above) about his views having lived in a time when extremes did happen in his country. He gives his thoughts below.
On extremes in investing in gold (100% gold vs. not owning any gold) and real estate:
Extremes are bad, and I know what you mean. There’s people that believe anything other than gold is worthless and others that state “When the world ends I’ll trade an egg for a bar of gold!” You can only roll your eyes and think ok buddy, you sit there waiting for doomsday while I live in the real world.
I’ve noticed that both my father and grandmother have one thing in common. Grandma was a farmer in Spain, when she came to Argentina she started a successful bakery shop, lost their savings several times for many reasons, inflation, change of currencies, takeovers, etc.
My father is an accountant, he worked in banks most of his life, was on the board of directors of bank Boston in Boston, Massachusetts, practically lost the money he had to put into his retirement fund in Argentina.
The thing they both have in common? After a number of economic changes, inflation and corralitos of various kinds, the only thing both of them have left were their real estate investments. Those survived better than money in the bank, and unlike the almost useless retirement plans, the rent will be what really allows them to retire and live well.
Thought it was worth mentioning. I consider real estate an important part of one’s portfolio as well.
FerFal brings up a point that I hope to explore more in the future. I believe strongly that investors should have what a poster at the Bogleheads forum “chicagobear” aptly called a “have money” and a “make money” side of their portfolio.
Inside the Permanent Portfolio you have four assets: Stocks, Bonds, Cash and Gold. Stocks and bonds are your “make money” portfolio as they pay interest, dividends and have capital appreciation. Cash and gold are more of your “have money” portfolio because they pay little in interest (such as cash) or have no interest or dividends like gold (but may have capital appreciation). However these “have money” assets have tremendous ability to ride out very bad markets when your “make money” assets are doing poorly. The “make money” and “have money” halves of the portfolio work together to lower volatility and provide good returns.
But FerFal brings up another interesting asset: Real estate. It combines the aspects of “make money” by giving you an income stream from rent but also is a “have money” as it is an asset that can’t be inflated away easily.
For the Permanent Portfolio, Harry Browne cautioned against using real estate as an investment as he considered it speculative in nature. In many respects this is true. However if you own rental property you do have potential to make money if you choose a good location, have good renters, can manage maintenance costs, have a good management company, etc. This is the speculative risk part. It could work out, but there is risk that one or more things could happen to make it not profitable.
What about Real Estate Investment Trusts (REITs)? You get the high income streams from owning real estate, but don’t get the calls at 3AM in the morning about a leaking roof. REIT index funds own a wide variety of companies that have exposure to malls, office buildings, public storage companies, etc. So you get geographic and industry diversification as well. However, by owning stock you don’t own the actual property itself which may defeat the purpose of real estate entirely as a hard asset like gold. Yet, for investors that want to have some real estate exposure, but don’t want the hassle, it may be an acceptable trade off.
As it is, in terms of “make money” and “have money” side of things, real estate seems to straddle the fence. It combines elements of stocks and gold investing (along with both of their risks). It is a hybrid asset. If owned directly it can provide inflation insurance that stocks and bonds may not. Yet it can also provide an income stream that gold and cash cannot. With REITs you give up the direct ownership, but they do provide a nice income stream which is hard to ignore.
Are there risks? Of course. There are risks involved just as you’d suspect and they need to be managed effectively. For instance, property management seems like one of the biggest headaches for real estate investors (but not for REIT owners). In Argentina FerFal handles it this way:
About managing real estate, I’ve found that in most cases its better to spend a couple bucks each month and let a real estate agency collect the rent and argue with the people you rent to.
In few cases, you find the right person and things run smoothly, most often it doesn’t and a middle man like the real estate agency collecting rent and making the calls if they get behind saves you time and lots of headaches. Besides, they [the renters] pay better ( pay when they are supposed to) when they dont have the actual owner in front of them to cry to.
Never heard of owning real estate through stocks [REITs]. Here, most people manage their own property, with a real estate office always taking care of the contract ( very important to have a good contract) and some have real estate managers like the ones I mentioned.
Here its important to be good at haggling like I say in the book. I’ve had very serious, suit wearing real estate agents cut down their managing asking fees down to 10% of what they where originally asking for. It’s important to know the market, know what a realistic asking fee is.I’m a nice guy and dont like pushing people ( people that come up with excuses for not paying rent) but like everything else, you learn little by little, know when someone really just needs a couple more days, or when he’s playing with you. Again, best thing is to have someone else take care of it, specially if you’re not planning on having much time to chase people around to get paid.
Here in the states many rental property owners do use management companies and this does seem to lessen the stress. They manage the renters, the maintenance, etc. There are some potential pitfalls to navigate though (such as the management company overcharging you for services and maintenance, carrying insurance, etc.). So rental property ownership is far from a sure thing and will take some work on your part to choose wisely.
However if you think you have the stomach for it, rental properties may be a consideration if you’re looking to have exposure to hard assets but also want that asset to deliver an income stream. BTW. I don’t think time shares fall into this category. I think time shares are the kind of investment made to be sold, not bought. Also, when we’re talking about owning real estate I feel we’re talking about property where you own the note yourself and not taking out loans to buy properties and risk you can’t make the payments. Taking out large loans to buy property other than your own home is a violation of Rule #7 of the 16 Golden Rules of Financial Safety.
If you don’t want to deal with any of these risks, or don’t have funds to buy additional real estate outside of your home, it may make more sense to look into a REIT fund like Vanguard’s REIT index (Ticker: VGSIX) or the iShares Realty Majors Index (Ticker: ICF). If you are eligible, the TIAA-CREF Real Estate Fund has an excellent reputation as well. These options provide inexpensive exposure to real estate with the trade off being you don’t own the property itself. If you are comfortable with that, the REIT funds above provide an easy way to get real estate exposure. They also have the other advantage that they are very liquid. Meaning that you can sell them in 60 seconds to get your funds instead of waiting days, weeks, months or even years to unload a physical property plus realtor commissions.
In terms of asset allocation, real estate is in the variable portfolio side of the house. Basically, only do it with money you can afford to lose. Also realize that if you own a broadly based stock index fund like the Total Stock Market you already own REITs. You just don’t own a lot of them in proportion to everything else.
Also remember that real estate does have risk just as all investments do. It’s just a question of diversifying these risks against all your other assets to reduce losses if they should show up. REIT funds dropped over 65% from their 2007 highs to their lows in 2008 as a recent example. And despite what realtors always claim about physical property prices, many areas experienced significant price drops in real estate that could take years, or decades, to recover. Yet, with the real estate bubble clearly popped in the US this asset could be a reasonable buy for someone looking to diversify a little of their play money and have some protection against unexpected events as well.
Thank you Fernando for answering my questions. Please be sure to visit his blog where he provides information on many topics.
Reflections on Gold
Dec 23rd
It seems that gold is one of these things that people really love or really hate. I try to stay impartial on the subject. I use it as a tool and don’t make it a religion. As it were, these debates always seem to come up and for some reason I get drawn into them.
In terms of gold, I never used to really think much about it as part of a portfolio. Yet, I came around on this subject. Ten years ago I wouldn’t have considered owning gold for many of the same reasons people commonly state. After getting badly burned in the stock markets during the 2000-2002 crash I started to realize that maybe there is something wrong in the approaches being advertised that use stocks and bonds only. It took a few more years before I really researched the subject and found out that gold in fact can be useful in a portfolio along with stocks and bonds.
Now, I’m aware of the arguments against gold. It has no dividends. It has no interest. It costs money to store. From 1981-2001 it went down in value. Etc. I get it. I read the same books and same expert opinions that everyone regurgitates on the subject.
Yet, the markets sometimes really want the stuff and they want it really bad – experts be damned. Usually they want it really bad when they don’t want your stocks and bonds so much. So I’ll sell it when people want it and buy it when people don’t. There is no religion about it despite my own personal feelings about how the dollar is mis-managed. I hold gold because I don’t inherently trust having 100% of my life savings under the direct and indirect control of the people printing the money. This is not an irrational behavior when you take the long view of history.
The opinions on gold being worthless, etc. are really irrelevant because 99.9% of the planet doesn’t really care what these people think. Don’t mean to be ugly, but that’s just the fact of the matter and someone’s PhD in economics isn’t going to change it. Gold has been wealth in just about all of recorded human history and referenced as such in most major religious texts and common use (“His word is as good as paper!” “This isn’t worth the gold it’s printed on!” “We consider our product the paper standard in the industry!” “In the Olympics he won three paper medals!” Oh wait that doesn’t sound right…). In other words, it’s not going away as a store of value and isn’t going to be reduced to raw industrial only use any time soon.
The question then becomes whether the history of gold and the nature of humans about the metal as a form of wealth is useful to a diversified portfolio. I think it is and I think that history bears it out that it can reduce volatility in a portfolio and provide capital appreciation when stocks and bonds can not. It can also serve as a powerful emergency reserve when paper currencies have problems as has happened countless times in the past around the world.
There are periods where gold is going to lag stocks and bonds. Duly noted. But there are other times where it will not. This can happen with any part in a diversified portfolio which is why you look at portfolios in total and not assets in isolation.
Because gold has much different economic drivers behind its performance compared to stocks and bonds, it can serve as a very powerful diversifier when it is needed most. In terms of dealing with bad inflation, I think gold has no peer and will knock the teeth out of inflation indexed bonds if we see very high inflation return to the US again.
With gold you take the good and the bad. Don’t give it supernatural powers, but also don’t discount it either. There isn’t an asset in the history of man that has the track record of preserving purchasing power that gold has. That has to be worth something I would think for those looking to hold a diversified portfolio.
Too much gold hype…
Nov 10th
If you want some no-nonsense ways to own Gold you can read my FAQ:
People are wondering about the gold price. Is it going to go higher? Is it going to go lower? Etc. Well the unexciting answer is nobody knows. That’s right, nobody at all knows. I don’t care how pretty their charts are or what logical arguments they have for or against. What I do know is that too many people are talking about the stuff.
If you own gold as part of your Permanent Portfolio allocation then you should stick to your plan and rebalance when it is needed. However, I would not go out and buy gold for my speculative Variable Portfolio bets right now.
I don’t think any particular asset class looks like a great buy for a Variable Portfolio speculation. So personally I’d just stick to the four way Permanent Portfolio split and not do much gambling with my money.
Now if you own gold in your Permanent Portfolio again I’d say to stick to the plan. That means you have a rebalancing band of either a low of 15% and high of 35% or a low of 20% and high of 30%, etc. If you are at or above your band then you should sell down your gold and rebalance the proceeds into your lagging assets.
Yes, I know it’s hard when you read all the doom and gloom but you have to do it. The point is you take an asset everyone wants and sell it to buy something that less people want.
The Permanent Portfolio is designed to limit risks and perform contrary buys and sells in the market. At any one time you probably are going to have an asset doing very poorly and another doing very well. This is how it is designed to work. But you need to be sure you do your part. That means selling down assets when they are doing great and using the money to buy the things people don’t want to touch at the time.
You hear that term “Bubble” being overused a lot now? “Gold Bubble”, “Stock Bubble”, “Bond Bubble”, “Bubble Bubble”. Well the way you limit losses due to “bubbles” is by rebalancing. No elaborate market timing is needed. If you own too much, you sell it down until you own less of it and buy something else. Simple stuff.
Are you nervous about the rise in gold prices and all the hype? Well I know some people are because I’ve heard about it. Here’s my advice:
If you have a rebalancing band that is 35% and your gold has risen to, for example, 33% of your allocation then perhaps you can sell it down early to 25% and re-deploy the money. I don’t think selling early in your rebalancing bands is going to hurt you much if it makes you sleep better at night. Perhaps in the future you make your rebalancing bands the 20%/30% thresholds so you keep a tighter control over how much money you have at risk in each asset. This can incur added tax and brokerage fees you need to be aware of, but it’s not terrible if it makes you feel comfortable. Remember, this isn’t a science so there are no precise answers to be had.
The one thing I would not do though is let any allocation slice rise above 35%. If you sell out too early and harvest those profits you will be OK. Sure you’ve not milked out the very top of something. But, as they say, only liars sell out at the very top and buy at the very bottom. But if you wait and let an allocation go to 40%, 45%, 50%, etc. you can set yourself up to take a tremendous loss if the markets turn suddenly. This isn’t just a warning for gold, it’s a warning for any asset class you hold.
This is just a reminder to not make gold a religion and use it intelligently in a portfolio. I don’t know what the gold price is going to do, but I don’t think you should listen to all the hype in the news about it either. Stick to your plan and don’t take risks with money you can’t afford to lose.
Permanent Portfolio 25% Gold Allocation FAQ
Oct 13th
This FAQ will be updated from time to time. I didn’t think it would be as involved to write as the other FAQs on Stocks, Bonds and Cash. What I found though is that there is just so much misconception about gold (both pro and con) that it needs a lot more detail. This FAQ is huge. It probably needs to be broken out. But I figured I’d post it all now because it’s been months since I promised it and if I wait until it is “done” then it could be many more months.
So this is a work in progress and will be updated as I get around to it.
Last Updated: November 19th, 2009
The Permanent Portfolio allocation is 25% stocks, 25% bonds, 25% gold and 25% cash. In this series of posts we’re going to talk about how to implement each one of these components to take advantage of the economic cycles of Prosperity, Inflation, Recession and Deflation. This FAQ is divided into two sections: Short Answers and Long Expanded Answers. If you don’t want to know the details then just read the Short section and skip the Long Expanded section. This page will be updated from time to time as more common questions and answers are needed. In this series we talk about the 25% gold allocation and how it protects you from inflation and other currency problems.
A New Swiss Gold ETF
Oct 7th
Blog reader Kyle sent me some information on a new gold ETF trading under the symbol SGOL. This ETF is a gold bullion ETF similar to the Street Tracks and iShares gold ETFS (Ticker: GLD and Ticker: IAU).
What makes this ETF different is SGOL’s gold is stored in Swiss bank vaults and not US financial centers. Since part of the Permanent Portfolio concept is to have some assets geographically diversified this could be an advantage. The expense ratio of this ETF is also very competitive as well at 0.39% which is right in line with the other offerings.
Now, some worry about a remote risk of US gold confiscation happening again in the future and this ETF would probably not prevent that (the govt. could simply pass an order requiring repatriation of funds for instance which would accomplish the same thing). However, this does give you a place for your assets that may not be open to the same type of risks as gold stored in the US. Risks such as from terrorist attacks, natural disasters, cyber attack, civil unrest, etc.
On the other hand, I’m not sure how if your US-based brokerage is having problems due to these issues here that it wouldn’t impact your ability to prove ownership in SGOL. Well, it’s a start at least.
This fund is brand new and I’m not one to jump into new financial products so I may give it time to build up some momentum. However, it’s something to consider for those that want to build a Permanent Portfolio and use ETFs for the gold portion but would like to have a modicum of geographic diversification.
Thanks again to Kyle for the tip.
Does Gold Preserve Purchasing Power?
May 26th
One of the more controversial holdings of the Permanent Portfolio is Gold. Once you understand what gold can and cannot do you may understand a little better why the Permanent Portfolio holds some of it in the allocation.
Gold is a preserver of wealth that is compact and historically viewed as valuable. It’s not an investment in a traditional sense. If you want growth of your capital you should rely on stock investing and bonds. If you want preservation of capital, then gold can help by protecting you from high inflation or other unexpected events.
Gold in a portfolio is a way to take money off the investment gambling table and putting it away so you can’t lose it easily. Further, a couple attributes of gold that are unique is that it is impervious to political shenanigans which can affect a paper currency and it can be owned in a way so that it is nobody’s paper promise to you. As one gold dealer said: “Nobody ever went to the poor house buying gold.”
These are distinct features that stocks, bonds and cash do not have and is why it is important to hold some gold as part of any investment portfolio. Gold by itself will not grow your wealth, but it has an uncanny ability to protect what you do have when your other investments aren’t doing well.
In terms of protecting from inflation, gold is hard to beat and has a very long track record of preserving purchasing power. Let’s look at some historic prices to see how this works.