It is not very easy to deal with human's own psychology when it comes to investment nor can it be changed overnight. Therefore, long-term investors should continue to invest in gold (physical form)
By Parthajit Kayal
A sharp fall in the equity market and an impressive jump in the gold prices due to the Covid-19 pandemic have brought everyone’s attention to gold. Does this magnificent performance make gold really worth for investment? Probably your investment advisor will say yes and ask you to keep 5-10% of your investment portfolio in gold, preferably in the paper form (ETF, bonds, mutual funds, etc). In my view that may not be a very good idea for everyone. When it comes to investment, it is more about psychology that determines the returns, not the assets.
Is gold worth the investment for the long term?
Over a long period, gold can be a better choice to get more returns than what you get in fixed deposits. Returns from gold could beat the inflation. Therefore, it may be suitable for risk-averse investors to go for gold investment. However, if someone is looking for better returns and can patiently wait for 10 to 15 years, then probably gold should not be the choice.
Historically, gold has always underperformed equity benchmark indices over a long term period of 15 to 20 years and more. Further, gold mainly performs during crisis periods, and doesn’t really move much in the normal periods.
Considering crises come once in every 10 years, investment in gold can make investors impatient with no returns for a long time. Nobody knows when will the next crisis will occur.
The opportunity cost of holding gold investment till the next crisis could be quite high. The investors have to forgo all the gains that could have been achieved through equity investment.
Years of negligible or negative returns could psychologically affect the investors and force them to sell gold investments with no gain or even loss. However, equity has given significantly high returns almost every alternate year.
Who should invest in gold?
The right investors for gold are those who are risk-averse, don’t really depend on gold for running expenditure, happy with an 8-10% returns over the long run, but need capital protection.
Does it sound familiar? Yes, the right investors for gold are mothers and grandmothers in the houses who buy jewellery, gold coins, etc.
Now, somebody may argue that there are a lot of disadvantages of buying physical gold and try to impress us with the advantages of buying paper gold like ETFs, bonds, or mutual funds. However, they fail to accept the most important disadvantage:high liquidity (instant buying and selling) in paper form of gold make the investors impatient.
The fear of paying making charges, taxes, etc, makes people hold physical gold for a very long time.
Unless the investors have enough self-control and patience, gold investment in paper form should be avoided.
Another set of investors who should invest in gold are those who are nearing their retirement and have the majority of the retirement corpus invested in equity. Imagine somebody retiring in 2020 had the entire retirement corpus invested in equity. This would have been a disaster for the person, unless other incomes are there to pay for the current expenditure, and wait patiently for the equity market to bounce back.
People who are nearing their retirement should consider moving 15-20% of their investment to gold. It would act as a life-guard by giving enough time for other investments to grow back. Somebody who is young and has sufficient emergency fund should not really bother to invest in gold.
What is the right way to invest?
It is not very easy to deal with human’s own psychology when it comes to investment and it also cannot be changed overnight. Therefore, long term investors should continue to invest in gold the way historically people in India have been investing in it. Yes, the physical form. It comes with a psychological protection which forces you not to sell it quickly.
The investors who are already retired or retiring soon should be the right investors for the paper gold.
They should not really expect a great return from it, but use the investment as a shield against bad times. They need to also increase the share of their portfolio in gold as they grow older.
The author is Finance professor, Madras School of Economics. Views are personal