Kevin Michels, CFP®, EA
With the stock market off to a dismal start this year, gold has responded as it should. SPDR Gold Shares (GLD) gained 4.63% while the S&P 500 as measured by the ETF iShares Core S&P 500 (IVV) was down 5%.
It’s at times like these when the stock market is highly volatile and posting negative returns that doomsday predictors and “gold-bugs” such as financial analyst Peter Schiff seem to be the only smart investors out there.
When fear dominates the market (as it has been since August of 2015) investors are quick to move from equities to other asset classes such as cash, bonds, and gold.
Although investors may feel like they’ve escaped danger by jumping out of the stock market, they face a whole new variety of risks depending on what they do with that cash.
One of the risks many investors may overlook when buying up gold in their investment accounts is the volatility associated with it. Risk in investing is often times associated with the volatility of your investment and when it comes to gold, volatility is abundant.
Whether you associate your success in investing to achieving a high rate of return, or earning a steady rate of return without crazy amounts of fluctuation, investing in the stock market, bond market, or in a diversified portfolio will beat investing purely in gold just about every time.
Just taking into account rate of return, since 1970 you would have fared better by investing purely in bonds, stocks, or a diversified portfolio.
Average Annualized Returns from 1970-2015
Gold - 7.68%
Bonds - 7.73%
Stocks - 10.27%
Diversified Portfolio - 9.80%
Investments with lower rates of return are usually associated with a lower amount of risk. However, since 1970, although gold had the lowest rate of return out of the four portfolios above, it also had the highest amount of risk as measured by volatility:
Standard Deviation from 1970-2015
Gold - 28.61%
Bonds - 6.59%
Stocks - 17.31%
Diversified Portfolio - 12.66%
If you can’t remember all the way back to your last stats class, when it comes to investing, an investment with a high standard deviation equals an investment with a high amount of volatility or risk.
To avoid boring you with all the math let me sum up the chart above by saying that over a 46 year period, bonds and gold earned the same rate of return, however, gold was 4 times more volatile than bonds.
Calendar year returns for gold ranged from -32% to 132% while calendar year returns for bonds ranged from -3% to 32%. With all else being equal, a rational person would take the less volatile investment every time.
Although gold may be seen as insurance against a large scale financial and economic meltdown, it isn’t an effective tool to escape the volatility of the stock market.
In fact, leaving the stock market to invest in gold will most likely increase the volatility of your portfolio while at the same time reduce your overall return.