Is it a good idea to add gold to your portfolio?


You may have heard the idea before that every responsible investor has at least a little bit of gold in his or her portfolio. But why is this, and is gold really a sound investment? 

In this video, Motley Fool Deputy Managing Editor Dylan Lewis breaks down exactly why people say gold is a good place to put your cash -- and whether theres any truth to that claim.

A full transcript follows the video.

Narrator: Hi, Im Deputy Managing Editor Dylan Lewis – and on this FAQ were going to be tackling a question we get all the time online – is gold a good investment?

There is a huge portion of financial media that fixates on gold. The most common argument youll see is that gold is a hedge for economic collapse – gold is seen as a safe place to store money because its been used as a form of currency for thousands of years.

That history, plus golds global appeal and limited supply sells a lot of people on the value of gold as an investment. But is it actually a good idea?

As an investor, youre looking to buy something that will be worth more in the future than it is today. To measure that, a lot of people will look at the intrinsic value – or the inherent worth of a company, property, or asset.

Most of this analysis will look at the money the potential investment over time might generate In the case of a company, youd look at the expected profits the business would generate over time. As a shareholder, youre a part owner of the business and so your stock entitles you to a sliver of those earnings. For a business that is growing over time, earnings should go up, and the value of your piece of ownership should follow.

Whats tricky about gold is that as an asset, it doesnt actually generate cash. The piece of gold you own today will be the same piece of gold 5 years from now, no more and no less.

If you buy a house, you can decide to rent it out, and over time the rental payments you receive could provide a steady flow of cash. Alternatively, you can live in the house and instead of paying rent month after month, you would be making mortgage payments and building equity over time in an asset that is capable of creating cash flows.

On its own, gold cant generate cash, which makes it harder to value.

The value of gold is really tied to its scarcity – that gives it value inthe jewelry market and it makes it useful as a store of value and means of exchange. Some of you probably heard that and thought what the heck does that mean?

Globally, gold is recognized as a precious metal, and that worldwide recognition means it readily can be exchanged across borders and cultures, which is part of the reason why major institutions like central banks maintain gold reserves.

Its also why some investors want in on gold.

They view it as a hedge against economic instability and inflation. Paper dollars, like the US dollar are fiat currency -- meaning they have value because we say they have value -- sound familiar?

So, if events unfold that lead people to question the value of a fiat currency, OR the government takes actions that change the value of a currency -- like printing way more bills and giving them out to people -- the currency can lose value. If a currency loses value, the relative value of gold, as expressed in that currency, will shoot up, allowing investors in gold to profit.

Some people keep money in gold because it is less tied to any one government and isnt as impacted by inflation or an economic collapse in any one country.

But its merit as an investment really depends on the timeline youre looking at. From September 2008 to August of 2011, the price of gold went up over 100% while stocks in the US eeked out 1% gains on a total return basis.

Theres money to be made investing in gold, but it comes down to being right about gold at the right time -- because gold tends to surge in value when major financial systems are struggling.

Since September of 2011, stocks have returned over 180% on a total return basis while the price of gold has fallen nearly 30% AND the returns of the S&P 500 trounce those of gold on a 1,3,5, and 10 year basis.

And for people with a very long time horizon, since 1990, The S&P 500 has posted 1,400% gains on a total return basis. Over the same nearly 30 year period, gold has returned 220%.

If you are worried about an economic downturn, it may make sense to have a small portion of your portfolio in gold, but it certainly shouldnt be your main investing strategy, and for many time periods, youd be better off being all in stocks.

Thanks for watching guys – if you have thoughts on gold, drop them in the comments section below. And if you have an idea for another video, let us know!

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