Few investments spark as much debate as gold. On one side of the spectrum, investors like Warren Buffett have dismissed gold and haven’t minced their words when doing so. Conversely, hedge fund billionaire Ray Dalio’s “All Weather Portfolio” allocates 7.5% to gold.
What’s important to understand is that it’s sentiment, rather than fundamentals, that often drives gold’s price.
This article aims to guide you away from fear-based decision-making and present the case for and against gold. Understanding the pros and cons lets you decide whether gold deserves a place in your portfolio.
Key Takeaways:
- The price of gold rises when demand rises. This has most often occurred during times of economic instability.
- The price of gold often moves independently from stocks. This helps reduce overall portfolio risk by offering diversification when stock markets are volatile.
- Historically, gold’s long-term returns have lagged behind the S&P 500. $1 invested in gold on Jan 1st, 1970, would be worth approximately $33.30 by October 1, 2024. In contrast, $1 invested in an S&P 500 index fund over the same period, including dividends, would be worth about $279.82.
- Gold doesn’t provide any dividends or interest; the only way to make money is by selling it at a higher price than you bought it for.
- Gold has limited practical uses compared to metals like silver and platinum, which have broader applications in industrial and consumer products. As a result, gold’s value is driven largely by perception and demand for jewelry and investment, making it a different kind of investment than other metals.
- Gold is not a necessary component of a portfolio for most investors. If you’re worried about volatility, investing a small amount of your portfolio in gold can help. But over the long-term, gold is unlikely to outperform a traditional portfolio of stocks and bonds. If investing in gold enables you to stick to your plan, fine — but unlike stocks, there’s no strong case that it should be in the everyday investor’s portfolio.
The Pros of Investing In Gold
Investors like Ray Dalio view gold as a hedge against inflation, a portfolio diversifier, and a safe haven in volatile markets. These benefits stem from gold’s unique characteristics as a store of value and a stabilizing asset. Here’s more on why some investors choose to hold it.
A Short-Term Hedge Against Inflation
Gold’s value has traditionally been linked to its finite supply. Yes, it can be mined, but after centuries of mining, there’s not a lot of easily accessible gold left. This means discoveries are costly and the gold that is found is more difficult to extract.
This is why gold is often seen as a hedge against inflation. Because unlike currency, it can’t be created out of thin air.
However, gold is by no means a perfect hedge. There have been times when inflation rises and gold does not follow suit. Here’s what the price of gold has done since 1915.
Compare this to what inflation has looked like over the same period, as shown in the chart below:
Here are two noteworthy examples of gold’s imprecise relationship to inflation:
- During the 1970s, inflation surged (particularly in the latter half of the decade) hitting double digits by 1979. Gold performed exceptionally well during this period.
- Following its peak in 1980, gold entered a prolonged bear market, dropping from $850 per ounce to around $250 by 1999. During this time, inflation continued its steady march, averaging around 3-4% per year, while gold failed to keep pace.
The charts above show that inflation compounds steadily over time, but gold doesn’t benefit from this compounding due to its volatility.
For example, if gold loses 50% of its value, it would need to double just to break even. Conversely, inflation consistently erodes purchasing power and rarely reverses, except in rare cases of deflation.
History shows that gold isn’t a great long-term hedge against inflation. However, it can be valuable in the short term, as it tends to rise quickly during inflation spikes, as you can see in periods like the 1970s when inflation surged. Gold prices also soared during the 2008 financial crisis, when fears of inflation and economic instability drove gold prices to record highs.
Gold as a Safe-Haven Asset During Times of Uncertainty
The real driver behind gold prices isn’t inflation but uncertainty. When markets are unstable, and the future is unclear, investors turn to gold — not just because prices might rise, but because gold feels like a safe investment when everything else looks risky.
In many ways, gold’s safe-haven appeal is rooted in human psychology. Gold has held value for centuries, symbolizing stability and wealth. In uncertain times, this psychological association makes gold feel reliable and comforting. While this perception doesn’t guarantee that gold will perform as a dependable hedge, it’s a powerful factor that drives demand.
For example, inflation wasn’t the immediate concern during the 2008 financial crisis or the 2020 pandemic. What drove gold prices up was fear; fear of economic collapse, failing banks, and an unpredictable future.
In these moments of uncertainty, investors flocked to gold.
Of course, to benefit from this, though, you need to hold gold before uncertainty strikes (not flock to it, as most people do). As the charts suggest above, gold prices move fast. Buying gold during a crisis means you’re probably too late.
In short, gold has historically performed well during periods of uncertainty, including inflation spikes. However, its real value lies in its role as a hedge against crises and extreme market instability.
While inflation and gold can sometimes appear correlated, gold’s performance is more about protecting against broad economic fears rather than serving as a reliable long-term hedge against inflation.
Portfolio Diversification
Investors like Ray Dalio include gold in their portfolios to avoid big losses when the markets crash. Here’s how gold performed during the five worst years for the S&P 500 over the past 50 years:
| Year | S&P 500 Return | Gold Return |
| 1977 | -11.50% | 15.70% |
| 1974 | -29.70% | 60.00% |
| 2001 | -11.90% | 1.40% |
| 2002 | -22.10% | 24.80% |
| 2008 | -38.50% | 5.50% |
Having a small portion of gold can offer some peace of mind for risk-averse investors and protection against significant losses in one’s overall portfolio.
Perhaps the most significant case for owning some gold is that it may allow you to stick with higher-performing assets like stocks, knowing that gold provides a degree of cushion if the market takes a hit.
While holding gold may limit potential returns — since it hasn’t kept pace with stocks over the long term — the purpose isn’t to match equity growth. Instead, it’s to add a layer of protection in times of market crashes. Gold helps reduce the risk of sharp portfolio declines, which can prevent panic selling during a downturn. For some investors, this stability is worth the trade-off.
The Downsides to Investing In Gold
Gold has significant downsides that every investor should understand before adding it to their portfolio. Here are the key drawbacks to keep in mind when investing in gold.
Limited Long-Term Growth
Unlike stocks, which represent ownership in companies that can increase profits over time, gold has no inherent growth mechanism. Its value is purely based on supply and demand, not its ability to generate cash flows.
The market has generally rewarded ownership in companies more than holding a store of value like gold. Consider this:
- $1 invested in gold on January 1st, 1970, would be worth approximately $33.30 by October 1st, 2024.
- In contrast, $1 invested in an S&P 500 index fund on January 1st, 1970, would be worth approximately $279.82 by October 1st, 2024.
Stocks also benefit from compounding through dividend reinvestment and earnings growth. With gold, there’s no yield component.
When accounting for inflation, gold’s actual returns are even less impressive. In many periods, gold doesn’t keep up with inflation.
The chart below shows the returns of gold and the S&P 500 by decade compared to inflation over that decade.
| Decade | Gold Return | S&P 500 Return | Cumulative Inflation |
| 1970 – 1979 | 1325% | 76% | 103% |
| 1980 – 1989 | -22% | 403% | 64% |
| 1990 – 1999 | -28% | 433% | 31% |
| 2000 – 2009 | 278% | -9% | 28% |
| 2010 – 2019 | 34% | 256% | 19% |
| 2020 – 2023 | 48% | 52% | 23% |
While gold can have its moments, history shows that a diversified portfolio based on stocks usually grows wealth more effectively over time. In other words, allocating a significant portion to gold means missing out on the long-term growth potential of more productive assets, such as stocks.
No Yield
Stocks can pay dividends, bonds pay interest, and real estate can generate rent. But gold? There’s no yield component.
This lack of yield means you’re missing out on one of the most powerful forces in investing: compounding returns.
When you reinvest dividends from stocks or interest from bonds, your money grows faster. With gold, you don’t get this benefit.
The only way to make money from gold is to hope its price goes up and sell it.
But remember: while you’re waiting for the price to rise, you’re not earning anything, and there are extended periods of underperformance.
Price Volatility
Gold is known for sharp price swings, especially during crises.
While this volatility can be a good thing, you must hold gold before economic stress hits to truly benefit from it. Unfortunately, most investors do the opposite — they buy when fear is high after gold has already spiked.
When markets stabilize, and gold prices begin to fall, they often sell.
To use gold effectively, it should remain a steady part of your portfolio, not just a panic-driven buy.
Holding gold requires discipline, especially since it often underperforms during stable periods. To succeed, you must take a contrarian approach, buying when gold is out of favor and selling when it’s popular (a strategy that’s simple in theory but hard to execute).
Storage and Security Costs and Risks
Holding physical gold requires storage and security, which adds to costs, reduces returns, and increases risk. Alternatively, you can buy gold with an ETF. But then again, you’re still paying fees with ETFs — you just don’t see them as clearly as you would paying a storage facility yourself.
My Thoughts On Gold
The typical individual investor doesn’t need gold in their portfolio. From an opportunity cost perspective, holding gold means not holding assets that have outperformed gold historically.
Still, many people are concerned about economic distress ahead, and holding gold can help mitigate those worries to some extent (though certainly not entirely).
My rule is that alternatives such as gold can have a place in a portfolio, but the portfolio itself must be structured to realistically put you on track for retirement.
It shouldn’t be based on a mindset of, “I think the price of gold will skyrocket because I don’t like the current president, and that’s how I’ll reach my retirement goals.”
For this reason, my personal limit is not to exceed 5%, or at most 10%, with any alternative investments.
Studies have produced mixed results regarding whether gold should be in your portfolio. Some studies, such as this one, say that gold isn’t necessary. Other studies, such as this one, conclude that 1% to 9% is optimal based on an investor’s risk tolerance. Of course, it’s easy to cherry-pick data, especially since gold soared in the 1970s after the U.S. dropped the gold standard. This makes it challenging to predict gold’s future performance based on past trends alone.
If someone holds 5% of their portfolio in gold, thoroughly understands the risks, and that allocation helps them stay the course with a more traditional retirement portfolio that will get them to their goals, you could argue that gold serves a purpose.
But gold is too unstable to make up a significant portion of the average investor’s retirement portfolio. No one knows where the price will head, and you can’t leave that much of your retirement up to chance.
