Gold – An Excellent Addition to Any Investment Portfolio!
Gold brings a significant reduction in downside risk and offers unique diversification benefits to any portfolio
In case you did miss it! I’m a big fan of gold, and my post below is one of the key reasons why. Enjoy!
I recently came across the following chart from WisdomTree, which very effectively illustrates the unique diversifying and risk-mitigating effect of gold within an investment portfolio.
Since there’s a lot of data in it, I’ll walk you through what the chart exactly shows, step by step. For example, the y-axis (vertical axis) displays the average annual return for a whole range of investment categories measured over the last twenty years. On the x-axis, you’ll find the ‘downside capture ratio’ of those investment categories. The downside capture ratio is a measure of ‘downside’ risk, assessing how well or poorly an investment category performs relative to another category when that other category decreases in value. For completeness: the light blue points represent bond categories, the dark blue points are all stock categories, and the turquoise points represent real estate and commodities. Then, there’s one gold-colored point, which is, of course, gold.
Downside Risk
Interpreting the downside capture ratio is less complicated than it seems. The investment category being compared here is global stocks, indicated in the chart as ‘World.’ And global stocks are represented here by the well-known MSCI World Index. The chart, therefore, shows how well or poorly an investment category performs relative to the MSCI World Index when it declines. If a category’s percentage on the x-axis is lower than 100%, then that category decreases less than the MSCI World Index when it falls. If the percentage is higher than 100%, that category falls more sharply than the MSCI World Index when it declines.
Now, back to the y-axis. The green arrow shows that investment categories that fall less than the MSCI World Index when it goes down generally achieve a lower return (y-axis). For instance, the light blue points indicate that bond categories fall less than the MSCI World Index when it drops, but this also comes with a lower return. Conversely, for example, Brazilian stocks, in the top right of the chart, often fall more than the MSCI World Index when stock sentiment is negative, but this is counterbalanced by a higher return than on the MSCI World Index. Thus, there’s a relationship between downside risk and return. Generally, less downside risk means less return and vice versa.
Gold Stands Out by a Mile
As you’ve probably already noticed, there’s one very clear exception: gold. Over the past 20 years, gold has achieved an average return of just over 8% per year, making it one of the best-performing investment categories. But here’s the kicker: the gold price does NOT go down when the MSCI World Index falls. The chart shows that gold’s ‘downside capture ratio,’ or downside risk, is 0%. This means that the gold price is completely insensitive to declines in the stock markets. While this is also true for some bond categories, they achieve a much lower return. And I’m not even considering my expectation that interest rates must remain low over the long term to keep the massive debt mountain affordable.
My conclusions based on the WisdomTree chart are simple. Gold deserves a significant place in every investment portfolio. Gold’s diversifying effect relative to stocks is demonstrably unique. Combining stocks and gold makes a portfolio much better. And on top of that, gold generates a very solid return.