Differentiating a good MF scheme from an average MF scheme

When we talk of asset classes in investment, the normal focus is on debt and equities. Nowadays, your financial plan also provides for some share of hybrid products to combine the benefits of debt and equity in a more customised format. The big question is should gold be included as part of your financial plan? Remember, when we talk of gold we are not talking about the gold in your jewellery; but we are talking of gold as an investment. This includes gold in the form of bars or gold in the form of e-gold or even in the form of gold bonds. In short, any product that helps you to mirror the price of gold can be included as gold investment.

But isn't gold an absolutely languid product?
 That is the standard refrain. How can gold help in wealth creation. After all, over long periods of time, gold hardly moves. It is only during short spurts like 1971 to 1979 and 2006 to 2011 when gold has given really attractive returns. The logic is; if gold has outperformed only twice in a span of 50 years then is it really worthwhile considering gold as an asset class? More importantly, does it really qualify to be part of your financial plan? The answer is "Yes". When one talks of including gold in the long term portfolio the idea is not to outperform the market. The focus is more on diversification than on enhancing returns or wealth creation. Remember, gold has no intrinsic value as it does not earn anything nor does not generate any returns. The price movement is normally a demand/supply equation. Let us look at 4 reasons why gold should be a part of your portfolio.

Gold is your best bet in turbulent times..
If you look at the historical price of gold, it has typically outperformed during times of turbulence and uncertainty. The period between 1971 and 1979 was a period of tremendous economic and geopolitical turmoil. The Gold Standard had collapsed, Israel was fighting a series of wars in the Middle East, Saudi Arabia had imposed an oil embargo on the US, Iran was battling Iraq and Russia had invaded Afghanistan. It was during this period that gold rallied from $35/oz to $800/oz. The next period of gold appreciation was between 2006 and 2011 when a combination of the sub-prime crisis, the Lehman crisis and the European debt crisis made gold extremely valuable. Even if you leave aside these periods of outperformance, gold is best suited to hold value when there is political and economic uncertainty.

Gold saves you from the risk of fiat currencies..
This is a slightly more complicated argument. Fiat currencies like the dollar, Euro, INR and Yen are issued based on a fiat by the central banks of these nations. Virtually, there is no limit to the amount of currency that these central banks can print. Over the last 9 years we have seen major central banks printing these currencies left, right and centre. This has led to the substantial debasing of these currencies. While this debasement is not immediately visible, at some point of time it will show up in currency value and also impact your portfolio value. But, gold being a non-fiat currency, has limited supply. Hence, it is broadly immune to debasement. That again makes a case for including gold in your portfolio.

Gold is a natural hedge to your portfolio..
The importance of gold arises from the fact that gold prices normally tend to have a low correlation to the movement of debt and equity. Equity and debt normally tend to form a curious pattern. In normal times, equity and bond prices tend to diverge while in times of economic crisis both the price of equity and debt crashes. Gold has a low correlation to equity and bond prices and hence including gold in your portfolio gives you a natural hedge. Even a 10% exposure to gold in your portfolio will give a natural hedge due to gold’s low correlation with other asset classes.

Gold has the longest surviving secondary market..
This is an interesting aspect about gold. Historically, it has been the longest surviving secondary market. That is because gold never goes out of demand and is a global product in the true sense of the term. If you compare the Dow Jones index over the last 70 years or the Sensex over the last 30 years, the components are vastly different. New stars have risen and old stars have fallen along the way. Therefore any investment in equity and mutual fund runs the risk of market churn. Gold is probably the only asset that is free from the risk of churn. You can be confident that even after 30 years there will be a robust secondary market for gold.
The crux of the story is that you must have an 8-10% exposure to gold in your long portfolio; ideally it can be demat gold. It will give your portfolio variety and also will act as a low correlation addition to your portfolio. As a hard asset, its stability has stood the test of time over the years!