One of the more vexing asset allocation issues advisors contend with is exactly how much of a client’s portfolio to commodities.
With the benefit of hindsight dating back to the start of 2021, advisors and clients now know that answer to what percentage of a portfolio should be allocated to commodities is “a lot.” Not being trite, but that is the proper answer owing to the fact that commodities are one of the best-performing asset classes over the past 18 months.
That time frame aside, the previous conventional wisdom dictated that, although there’s no one-size-fits-all approach, a typical portfolio ought to have 5% to 10% directed to commodities – the bulk of which would usually be allocated to gold.
As was recently noted in this space, gold is something of a disappointment this year, particularly when considering inflation remains onerously high. Still, bullion, as measured by the SPDR Gold Shares (NYSEARCA:GLD), is outperforming stocks and bonds this year.
Attempting to Right-Size Gold Exposure
Gold’s long-standing reputation as a safe-haven makes it alluring for a variety of clients, particularly in turbulent times like these. Again, yellow metal is producing negative returns this year, but significantly less so than equities and most fixed income assets. On the other hand, exactly how much gold improves a portfolio’s performance is a point of debate.
“Gold, along with commodities and cash, was one of the few places where investors could take shelter. Gold has mostly stayed in a trading range in recent months (priced at about $1,737 per ounce as of this writing), but still ranks as one of the better-performing asset classes in this year’s market rout,” says Morningstar’s Amy Arnott. “While gold has proved its value as a safe haven, though, its ability to improve portfolio performance over longer periods is less convincing.”
One way – arguably the best way – for advisors to convey the benefits of gold to clients is in terms of a buffer in rough times. That can mitigate disappointment while validating SMALL allocations to bullion within client portfolios.
“Over longer periods, gold has consistently excelled during bear markets and periods of unusually high market volatility,” adds Arnott. “Gold has posted significantly better returns during previous market drawdowns. While its performance during the novel coronavirus crisis was a partial exception, gold has more often notched positive total returns during periods of deep losses in the equity market.”
Said another way, gold is useful in modest, small doses, but it’s not going to energize portfolios in material fashion.
Other Reasons to Keep it Small with Gold
Warren Buffett famously said gold “just sits there.” It produces no income. No interest payments. No dividends, meaning clients are subjected solely to a capital appreciation wager. That further cements the notion of keeping it small with bullion.
Another reason to not overdo it with gold is that while it’s effective in bear markets, it’s far from guaranteed it will rise in unison with other assets.
“The problem with gold is that while it can excel in bear markets, its performance in other market environments is uneven, to say the least,” concludes Morningstar’s Arnott. “For example, gold lagged stocks during most of the 1980s and 1990s, and generated negative returns, on average, during those periods. It excelled during the inflationary environment of the 1970s and the “lost decade” for stock returns in the 2000s, but then fell well behind stocks starting in early 2010.”