Category: Money & Finance

Gold’s Role In Today’s Modern Investment Portfolio

What Role Should Gold Play In Today’s Portfolios?

To some people, suggesting that gold should be part of a balanced investment portfolio is like suggesting leeches are a way to cure ailments. Many investment advisors consider gold to Investment Managementbe a ‘barbarous relic’ that has no place in today’s modern portfolio, given our current financial innovations and instruments.

Yet when examined carefully, it is clear that gold is another asset that has the potential to add non-correlated returns to a portfolio. In this manner, it actually fits very well with modern portfolio theory, and gold should be incorporated by all investors and responsible financial advisors.

Why gold gets a bad rap as an investment

One of the biggest misunderstandings about gold as an investment is an unfair comparison to other financial assets. Gold is not an ‘investment’ in the sense that it brings the expectation of a positive return or cash flow, like stocks or bonds that pay interest or dividends.

An ounce of gold in your portfolio today will be an ounce of gold 100 years from now. It will not magically grow, expand or compound. It will not pay anything in return, and will likely cost a very small amount in storage fees or insurance. This is why gold is sometimes referred to as a non-productive financial asset.

As a financial asset, it is also criticized as something that only keeps up with inflation over the long-term, usually underperforming stocks and bonds, while exhibiting price volatility. But this is unfair and a misrepresentation of the essence of gold and the purpose it serves in a portfolio. Gold should never be considered as a stand-alone investment, but always as a part of a portfolio.

How to evaluate gold

Gold EvaluationThe main function of gold is to protect purchasing power, both locally in terms of inflation as well as globally in terms of currency fluctuations, and to mitigate risk. Gold performs well in times of stress or domestic/international crisis, as well as serving as one of the most liquid of all assets and commodities.

In other words, it doesn’t make sense to evaluate something based on criteria that do not apply. After all, you wouldn’t evaluate a bus by how fast it can go and then compare it to a Ferrari. A bus is not designed for speed and high performance, but for transporting a large number of people.

Similarly, some people inappropriately evaluate the nominal returns on gold and compare this to the performance of stocks. But the purpose of holding gold is not capital appreciation, but capital preservation.

Those familiar with modern portfolio theory understand that the holy grail of investing and asset allocation is to obtain more return and less risk. An asset will be added to a portfolio if it can significantly reduce risk without giving up much in terms of return. This is akin to the concept of correlation, or how much two assets move together: either in step with each other (correlated) or out of step (non-correlated).

Physical gold has either very low correlation or even negative correlation to almost all other asset classes, including stocks, bonds, cash, real estate and even other commodities. Therefore, even though gold can be quite volatile in price, those swings are usually going the opposite way of other major asset classes like stocks.

Therefore since gold is such a good diversifier, reducing risk without giving up much reward, the question is: how much of your portfolio should be in gold?Gold Investment

In a white paper, Merk Investments ran a few portfolio simulations that reverse-engineered the proper amount of gold. In other words, the study found what percentage of a portfolio should be invested in physical gold in order to achieve the highest return for a given amount of risk, something financial practitioners refer to as the efficient frontier.

The study found that from 1971 through February of 2014, a whopping 29% allocation to gold would have achieved the best risk-reward profile for a portfolio, compared to 100% in stocks; this, despite gold being more volatile than stocks during this period.

To be clear, the study does not state this as investment advice; it is simply finding the percentage number that fits the historical data. However, the study clearly drives home the point that a surprisingly high percentage allocation to physical gold would actually improve the risk-reward balance of a portfolio.

Of course, portfolios are not merely divided between stocks and gold. Other non-correlated assets can also be added, such as real estate or other commodities. Previous studies over the years have found that a 5-15% allocation to physical gold is therefore reasonable.

Here at Anthem Vault, we believe a reasonable allocation to gold is 10-20% of your investment portfolio, depending on your level of risk acceptance and other factors. Contrary to the opinion of some, and in-line with historical data and modern portfolio theory, this allocation can greatly lower your portfolio’s risk without sacrificing returns.

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Only Gold Lowers Risk, Compared To All Other Financial Assets

risk concept in clamp

Gold clamps credit and counterparty risk down to zero!

When reviewing the benefits of owning gold, one of the factors consistently at the forefront is the fact that gold has no counterparty risk. Counterparty risk is the risk incurred by having one or more other entities (counterparties) involved in a party’s transaction, such that they may be unable to fulfil their financial obligations to the party.

In fact, gold is risk-free in terms of credit and counterparty risk. It’s a concept that is thrown around a lot in the gold community, but few actually know what it means. Although it seems obvious once you understand it, the implications are very serious. Let’s first look at counterparty risk as it relates to gold because this is the most simple example, and then we will compare this to other asset classes or forms of financial wealth.

Gold is… well, Gold!

Gold bars

Gold is the only financial asset with no counterparty or credit risk

Gold is a very dense precious metal that has a physical composition that makes it ‘gold’. If you own an ounce of gold, it is yours, just like you own a pencil. Once you own a piece of gold, nobody else has a claim on it. You probably traded something for it, or bought it with cash. But once you own it, that person with whom you traded no longer owns the gold, has control over it, and will likely forget about it.

This of course may seem all too obvious, but the power of this simple observation will become clear as we compare gold to other financial assets.

EVERY Other Financial Asset Class Has A Counterparty

For example, consider corporate bonds. If you purchase a bond from a company, you own that bond and have rights to it. However, that bond is not just recorded on your personal balance sheet as an asset, it is also concurrently on the balance sheet of the company that issued it, and it is recorded as a liability on their books.

A holder of a bond is not just an owner of the bond, but has entered into a contractual agreement with the bond issuer. Counterparty risk is the risk that the entity on the other side of the contract will not fulfill their obligations; in this case, the risk that they will not repay the bond when it is due or make the required interest payments to you, the holder.

What about government bonds, which are considered risk-free? Government bonds are usually considered risk-free because governments have the power to tax their citizens to make their bond payment obligations. Unfortunately, there are limits to this, just ask Puerto Rico.

Governments that control their own money supply are considered to be even safer, because they can just print money to cover any bond repayment shortfalls. Yet this does not remove the counterparty risk. Holders of bonds will be repaid, but Out Of Stockwith devalued currency.

What about money in banks, such as simple checking and savings accounts? Surely there is no counterparty risk here, as the money is there to be withdrawn at any time, right?

Money deposited in a bank is an asset on your personal balance sheet. But for the bank, it is recorded as a liability, because the bank must be ready to redeem any request for that money, at any time you want to withdraw it.

When a large number of customers want to withdraw their money simultaneously – known as a bank run and usually the result of panic – the bank’s reserves may not be able to cover the withdrawal amounts and the depositors’ money is at risk. Yes, there is FDIC insurance, but this is just another counterparty, and the FDIC in turn receives its money from the U.S. Treasury: another counterparty to add to the list. Furthermore, ask anyone in Cyprus who experienced a ‘bail-in’ if they still believe their deposits are completely safe in a bank!

Finally, what about cold hard cash, withdrawn and stuffed under a mattress? Isn’t this exactly the same as storing an ounce of gold? No. The Federal Reserve issues those notes, hence the words Federal Reserve Note at the top of each the bill. Therefore, the Federal Reserve Notes that are outstanding and in circulation are a line item recorded on the Federal Reserve’s balance sheet as a liability.

Since you cannot redeem a dollar for anything but another dollar, the counterparty risk is that the currency may fail completely or at least be devalued, something we have certainly witnessed consistently over the past hundred years.

Many people believe gold is a very risky financial asset when compared to traditional vehicles like stocks, bonds, savings accounts and even physical cash. Yet all of these possess counterparty risk, while outright ownership of gold has absolutely no counterparty risk. If protection against turbulent financial conditions is one of your goals, gold is the only financial asset in your portfolio that will not carry this very real and significant risk. 

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An Investment Portfolio for our Uncertain Times

climber-299018_1920If you could describe your dream investment portfolio, what kinds of characteristics would it have? It would probably be one that had steady, positive returns with very little risk, was simple to set-up and maintain, and could weather any kind of investment climate. While a perfect portfolio is probably unattainable, the Permanent Portfolio gets pretty close.

The Permanent Portfolio was first advocated by Harry Browne, an investment analyst and two-time Libertarian Party Presidential nominee. He outlined the asset allocation strategy in his 1999 book Fail Safe Investing: Lifelong Financial Security in 30 Minutes.

In my last post where I reviewed a book that looked at investing from an ‘Austrian’ perspective, I mentioned how the Permanent Portfolio was a tool that regular retail investors can start using today to protect themselves against our current monetary confusion.

The theory behind the Permanent Portfolio is straightforward. Since the future is uncertain – especially in terms of inflation, deflation, growth and recession – why not construct a portfolio that can take advantage or defend against any of these combinations?

The portfolio is designed to weather any kind of storm and, most importantly, to protect against major drawdowns or losses. It is also constructed in a simple and understandable way so any investor can implement it.

Millennialisms

piggy-bank-850607_960_720Everyone loves to hate millennials these days. They are characterized as being lazy, entitled and self-absorbed. As is sometimes the case, those stereotypes might have some sort of basis in reality, but as is almost always the case, that’s not the whole story. Laziness, entitlement and narcissism aren’t all that millennials are good for. According to some recent studies, they’re also pretty good at saving. Maybe even better than their elders.

The percentage of millennials saving more than 6% of their income has increased substantially from last year. Not only that, it has surpassed the percentage of people in the 30-49 age range saving more than 6% of their income. Many have attributed these saving habits to the fact that millennials had to watch older generations struggle through an economic recession, as they were growing up. Keeping a healthy savings account is a precaution they can take against the economic troubles that their parents and grandparents faced.

My Three Millionaire Friends All Have This in Common

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There is an old saying that those of average means ought to take their rich friends to lunch. Having long heeded this wisdom, I’ve been privy to a great deal of sage advice from these wealth masters.

Admittedly, I was quite surprised to discover one thing in common between them – a factor they all indicated was pivotal in their quest for financial freedom.

That factor? They have all chosen to forgo the use of electronic calendars on their computers or mobile devices, in favor of paper calendars. Yes, you heard right. Harking back to the post-Internet days when desk calendar blotters and pocket planners were in vogue, these three digital Luddites have elected to turn back the clock, at least in terms of planning their daily schedules.

Now for some breaking news. I have made the decision to join them. Yep, I’m ordering my PassionPlanner today.

Back in the 90’s when I was a freshly minted entrepreneur in my Armani suits, hustling for business in Chicago, I carried around the infamous Franklin Planner, a creation of that iconic time management expert Stephen Covey. Back then, Franklin had these huge Apple-ish retail stores where enthusiasts could pick up everything from calendar filler pages to pricey leather-bound briefcases in which to house their scheduling systems. They offered seminars on how to effectively manage your personal and professional activities, replete with a simple yet effective system for assessing your A-B-C priority list.  For me, The Franklin – as it was affectionately known – was my go-to source for everything I needed to maximize my day-to-day productivity.

Fast forward to 2007 when smartphones first appeared on the scene en masse. It was at this point that all reasonably minded people began to question whether it made sense to migrate the calendar function over to our electronic devices. Given my proclivity for being an early adopter, I was among the first to make the jump. And frankly, I’ve regretted it ever since.

What Investors Can Learn from Sound Economics

Austrian School for InvestorsReaders of this blog will be familiar with the Austrian School of Economics; the school of economic thought whose name derives from the fact that many of its early scholars came from Vienna. The school adheres to the individual as the basic unit of economic analysis, and it focuses on the market process.

The Austrian School is noted for some of the fundamental concepts that endure in mainstream economics today, and one of its prominent scholars, F.A. Hayek, received a Nobel Prize in economics. But does the school have anything to offer in terms of investment advice?

Enter the recent book Austrian School for Investors: Austrian Investing between Inflation and Deflation. Continuing with the theme here at Anthem Vault of being financially responsible by reading and continuing one’s education, I was delighted to read through this book, a volume that sits at the crossroads of my two main intellectual interests: Austrian economics and investments.

If you feel like recent economic developments concerning central bank quantitative easing, negative interest rates and government stimulus programs are leaving you confused as to how to invest your money, then this book is for you.