Money
To invest or not to invest: The gold conundrum in your portfolio
Summary
Gold does not beat equity over a multi-decade period, but it is a great diversifier in the portfolio
Here is the reason why all that glitters is gold now and also why many investors have taken a shine to the yellow metal. Gold prices have delivered more than 14% returns in the one-year period ended 30 March even as equity markets have remained tepid during this period. For instance, the S&P BSE Sensex delivered returns of just 2% in this period.
Equity or gold, or both? That has been the subject of a long standing debate in personal finance. Equity-bulls point out the wealth creation power in stocks that comes from economic growth and the increase in corporate profits over time. Gold, however, does not yield any interest or dividends. A rise in gold prices is simply the result of its finite supply even as the stock of money chasing it keeps rising. Add to this the demand for gold jewellery among women, particularly in Asia. Also, it has a negative correlation with equity. So, despite its grim outlook, gold has a place in an investor’s portfolio because it is a powerful diversifier.
The very long term
If you look at very long periods of time, gold does not create wealth like equity does. The starting value of the Sensex was 549 in 1986. It was around 58,000 as of 30 March. From 1986 to 2023, the Sensex compounded at 13.4%. In 1986, the average price of gold was ₹4,625 per ounce. Today, it is around ₹1.6 lakh. What has gold’s return been? The answer is a compound annual growth rate (CAGR) of 10%. This means that a single rupee invested in Sensex in 1986 has yielded ₹105 while the same invested in gold is worth just ₹31 today. The disparity in the two applies over shorter time-frames also. The 10-year CAGR of gold is 6%, compared to 13% for equity. What’s worse is that gold’s returns are lumpy. After prolonged periods of stagnation, it suddenly soars.
Equity, which exhibits a more steady upward climb, is also volatile. It goes through long spells where there are no returns. This can be observed if you compare the three-year rolling returns of the two assets. Rolling returns is a concept that adjusts for different start and end dates. The minimum 3-year rolling return in equity (using NiftyBeES, a Nifty exchange traded fund as proxy) over the past 15 years is -6%. In the case of gold, this figure is -9%. The average (median) 3-year rolling return for equity is also higher at 11.1%, compared to 10.1% for gold.
Gold in your portfolio
The case for gold is one of diversification. If you compare the returns of the assets for each financial year from 2013 to 2022, you will see that the two assets have a negative correlation of -0.6. In other words, equity performs well when gold falls and vice versa. This enhances the stability of the portfolio, giving you a more consistent investment experience. This is the sole reason for having gold in your portfolio, even if having it means that you are sacrificing some return compared to a 100% equity portfolio. Normally, financial planners recommend an allocation to gold that ranges from 10% to 20%, depending on your risk appetite and market conditions. “Due to its negative correlation with relatively risky assets like equity, gold is a good way to diversify one’s investment portfolio. Gold is also a good diversifier for periods when the rupee is depreciating sharply. Gold allocation can be part of one’s portfolio and rebalanced at regular intervals to maintain your original asset allocation target," said Deepesh Raghaw, founder of PersonalFinancePlan.
How can you invest in gold?
You can invest through gold ETFs (exchange traded funds) or gold savings funds. However, the gains will be treated as short term regardless of holding period with effect from 1 April. In contrast, gains in physical gold after a 3-year period will be taxed at 20% and you will get the benefit of indexation. The same treatment applies to gains in sovereign gold bonds after a 5-year lock-in period. These bonds are issued by the government periodically and track the price of gold. You can buy them through your bank or broking account. If you hold them till maturity (eight years), the proceeds are tax-free.
You can also invest in gold though multi-asset funds which hold various asset classes such as equity, debt and gold. However, check the asset allocation in such funds. If the allocation to equity is 35% or below that, it will be treated like a debt fund, which means the capital gains will be taxed at investor’s income tax slab rate. Equity at 65% or more will mean that the tax rate drops to 10% for gains above ₹1 lakh. This is applicable when the holding period is more than one-year and long-term capital gains tax rate apply.
