Is gold a better investment than bonds for reducing risk?


By Matt Krantz, USA TODAY
Posted 13h 28m ago |

Q: Investors who wanted to reduce risk bought bonds. Is gold the better investment for risk-adverse people now?

Ask MattBy Matt Krantz

In A one kilo gold bar on display along with a 1621 Sigismund III Gold 100 Ducat coin at Stack's Rare Coins in New York.
EnlargeCloseBy David Goldman, for USA TODAY
In A one kilo gold bar on display along with a 1621 Sigismund III Gold 100 Ducat coin at Stack's Rare Coins in New York.
A: Investors are programmed to spread their money between two major asset classes: stocks and bonds.

One of the widely followed adages in investing is that the percentage of your portfolio invested in bonds should be roughly equal to your age. The advice is pretty general, but still a good basic guide.

Say you’re 40 years old, for instance, then a traditional target portfolio would call for 40% of your money to be in bonds and 60% in stocks. You could add different types of stocks and bonds within the bond and stock targets, but you’d want to aim for the basic 40% bond and 60% stock mix.

The idea is based on two fundamental concepts, which will tie into your question about gold, I promise.

First of all, typically, but not always, the older you get the less tolerant you become of risk. The older you get, the less time you have to wait for your portfolio to recover from market downturns. Also, when you’re older, you may be more likely to need to spend the money you’ve invested and can ill afford to sell investments amid a downturn. Age isn’t always the best determinant of your appetite for risk, though.

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The second part of why splitting your portfolio between stocks and bonds is a good strategy has to do with the fact that bonds have historically been much less volatile than most other investments.

One measure of bonds, the IFA Five-Year Global Fixed Income Index, has posted an average annual return of 4.96% since 1928. That might not sound like a great return, but here’s the part that wins bonds lots of friends. The risk, or standard deviation, of the bond index is just 3.65 percentage points. That means most of the time, investors in global bonds can expect to earn an annual gain of 1.3% or 8.6%, or something in between.

Bonds are much less risky than stocks. Compare the bond data above with stocks. The Standard & Poor’s 500 index has posted an average annual return of 9.5% since 1928. However the risk, or standard deviation, is much higher than bonds’ at 19.29 percentage points. That means stock investors can expect to earn anywhere between a gain of 28.8% or loss of 9.8% or something in between.

But what about your question? How about skipping bonds altogether and going with gold instead. Given the solid run gold has had, some investors might start wondering if the metal could be a better safe haven than even bonds.

After all, over the past three years, the value of gold tracked by the SPDR Gold Shares ETF (GLD) is up 40.4%. And even during 2008, a brutal year for stocks and when even silver fell 25%, gold ended the year roughly flat. And since 1979, the S&P GSCI Gold index returned 6.4% a year on average, according to data collected by Morningstar. This all makes gold seem much better than boring old bonds.

But here’s the problem with why gold is not a substitute for bonds. Gold is much riskier than bonds. Since 1979, gold has had risk, or standard deviation, of 21.3 percentage points, says Morningstar. Yes, you read that correctly. Gold is 232% more risky than bonds and even riskier than large U.S. stocks. So if you shift into gold thinking you’re protecting yourself, you may very well be boosting your risk and subject your portfolio to extreme peril.

If the current precious metals binge proves to be a bubble, as many expect, there could be a vicious bear market in gold.

And if you do shift some of your money into gold, be sure you know what you’ll do if the gold market begins to sink. Gold and silver bear markets can be vicious, so if you’re going to gamble on these metals, have an exit strategy. Or, if it makes you feel better, an argument could be made for a small stake in gold. But just don’t be surprised if in five years, gold not only underperforms bonds but also brings more risk and volatility.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz

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