In such times, investors tend to panic and start looking for a 'safer' investment options. In the search for an alternate asset class, investors start evaluating the merits and demerits of investment options like stocks, mutual funds, gold, real estate, etc.
In volatile markets, investors usually lean towards investing in gold. Traditionally, gold has been viewed as a ‘safe haven’, especially in India. Indians are the biggest consumers of gold and are usually invested heavily in the form of gold coins and jewellery.
There are a few problems associated with holding physical gold, such as safety and storage.
Storing gold in large quantities at home becomes risky and there is always a risk of theft. Alternatively, people store their physical gold in bank lockers, for which they have to pay maintenance charges/fees every year.
Apart from storage and safety, another issue with gold is that of liquidity.
Even though physical gold can easily be liquidated over the counter at a jeweller, there are various charges associated with this. One loses a lot of money in melting jewellery and ends up getting a lot lesser money as compared to the price paid for buying the jewellery.
Simply put the resale value of gold decreases due to jewellery ‘breaking’ charges. One must not forget that there are high making charges with respect to buying jewellery as well. Further gold investments are considered as a sign of ‘wealth’ and usually have a lot of emotional value for most Indians. Hence, in times of need, people get very distressed selling their physical holdings in gold. This defeats the main motive of buying gold to use it at the time of uncertainties and hence makes it an illiquid investment.
While some amount of gold can be held for personal consumption, is it really a great investment option? The answer is no!
The fundamental reason is that gold itself as an asset does not have any earning power unlike other investments. Investments in other asset classes like equity stocks, deposits with banks, company or government bonds have an earning power. This means that when you invest in a particular stock or bond of a company, the company will utilise the same money to grow, generate wealth and contribute to the economic growth of the country. Similarly, when you invest in Bank Deposits, the bank further lends this money in the market, to individuals and companies that utilize the same to grow their businesses.
Stacks of Gold bars is every investors dream. But is it earning dividends?
Gold on the other hand is an idle asset, i.e. it is an unproductive asset. In the sense, that it does not grow, compound, or provide any form of income. As Warren Buffet rightly said, "It’s a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that."
Further, any growth in the value of gold solely depends on the belief that the demand for it will increase in the future. Hence, it is evident that people invest in gold as they believe that they will be able to sell it at a higher price in the future. However, this may not always be the case, thus making gold a speculative investment.
With respect to returns, in the long run, gold has given returns only in line with inflation rate. The post-tax returns from gold are way lower as compared to alternate investment options like equity, in the long run. Further, investment in gold does not provide any current income like dividend or rental as in stocks or real estate, where investors can reap the rewards of their investment without having to sell their asset. Hence, from an investment perspective, it is surely not a great option.
However, if you still cannot resist the temptation to hold some gold, you can take exposure to gold through ETFs or Gold Mutual Funds. Gold ETFs invest money pooled in from investors, in standard gold bullion. They track the domestic price of gold and hence, if the price of gold declines, the value of the ETF falls, and vice versa. Gold funds, on the other hand are mutual funds that invest in Gold ETFs and Gold mining companies. ETFs and Gold mutual funds can be held in electronic form. However, for investments in ETF one needs to have a demat account, whereas investments in mutual funds can be done directly.
Since they are not physically stored the worry of storage and theft is eliminated. Further, they are more liquid than gold bars or jewellery as they are freely tradable. Considering the above factors, it is better to have exposure to gold through ETF/Funds rather than physical gold.
From an asset allocation and diversification point of view, only a small portion of your portfolio can be allocated i.e. not more than 5%, towards gold. However, for long term achievement of goals and high post tax returns, we would recommend investing in other asset classes like Equity and Debt.
As an investor, one must understand that instead of worrying about fluctuations in returns and short-term volatility in markets, one must focus on achieving long term financial goals. The best way to tide over market volatility is goal-based investing.
Simply setting aside some amount as savings is not enough. All investments must be made with a purpose in mind i.e. a goal. We all have goals that we aspire to achieve in our lifetime. These goals include milestones like children’s higher education and marriage goals, retirement goal, annual vacation goal and other dream goals like buying a dream house, car and so on.
Take the help of a financial advisor to help you list out your life goals, and help you Prioritize, Plan (how much you need to save) and Invest (where to invest) to achieve these goals. Further, periodic reviews will also ensure that you stay on track towards achieving your goals.
The reason goal-based investing is so successful is primarily because when you set a goal you are emotionally invested in the process and tend to save diligently to meet the goal. Further, this process takes into your account your risk appetite, time horizon, and other specific needs. Thus, when you have a focused goal-based approach to investing, the market fluctuations tend to affect you less.
Thus, in times of market volatility, instead of worrying and evaluating various investment avenues, one must only focus on his/her goals and stick to the financial plan as recommended by your advisor.
Amar Pandit is a Chartered Financial Analyst and the Founder, Chief Happiness Officer of HappynessFactory.in
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