Should I invest in Gold?

Lately, there have been tons of radio and television advertisements encouraging us to purchase gold. Is gold really a great hedge against inflation? Is there any truth to the commonly heard prediction that the price of gold will reach thousands of dollars in the near future? How accurate is advice from supposed financial pundits claiming that we should be purchasing gold coins or gold certificates?

Here is what we know. Based on data from the Austin Gold Information Network, the price of gold has increased thirty eight times between 1871 and 2009. We can compare this with inflation (CPI) and the performance of the S&P 500 index. Based on Professor Robert Shiller’s study, CPI increased seventeen times and S&P 500 (discounting reinvested dividends) has increased one hundred ninety five times. So yes, gold can be a good hedge against inflation but stocks are a better hedge in the long run. If you decide to invest in gold anyway, do not be disillusioned! Investing in gold also has its risks. In 1980, the price of gold was nominally roughly the same as now. Adjusting for inflation, people who invested in gold 29 years ago are actually losing money right now.

My advice would be not to purchase actual gold in the form of bullion, coins, or certificates. They are not liquid and can be a hassle to store securely. Furthermore, you are always running the risk of uninsured theft. The simplest way to invest in gold is to purchase Gold ETF. Like most investments, it works through a third party: you purchase shares and the fund company purchases gold bullion accordingly, storing it securely. You can sell those shares at any time. It is a very easily liquidated and secure investment. And you never need to worry about the logistics.

If you are still inclined to invest in Gold, definitely do not make it more than 5-10% of your portfolio. There are other ways to hedge against inflation: REITs, commodities, and other precious metals, for example. Remember, diversify!

Shall I invest in the stock market now?

Recently, a friend of mine asked for my advice: is now a good time to purchase an S&P index fund for his retirement account?

Before I tell you what I think, a little history on the aforementioned friend:
For one, he is in his thirties and will probably not need that money for approximately twenty five years. Furthermore, he feels that during that time he will not lose sleep over market volatility. Not long ago, I showed my friend how to build a diversified portfolio in his retirement account – large caps, international, real estate, etc. At that time, we decided that he should have an S&P 500 index fund as a representation of a large cap stock. Since then, he has transferred money from his old 401K to a newly opened IRA account and is asking whether he should wait to invest in the S&P 500 or if he should buy it now.

This brings me to the facts:
- According to Professor Robert Shiller, since 1871 S&P 500 (or its equivalent until 1950s) never lost money in any 25 years period. See here for details.
- According to Ray Lucia, CFP the worst 25 years period since 1950s would have ~7.9% compounded annual rate of return.

While we cannot say for certain what the next twenty five year period bring, history serves as a good indicator. We cannot predict the stock market but we can use statistics to make educated decisions.

From a different perspective, we can also look at it this way: S&P 500 is more than thirty percent off its peak. Of course it might fall to extraordinarily low levels, but it may also rise – you just never know.

So back to the original question: what advice did I give to my friend? Buy the S&P 500 now. Base your decision on the long term trends. Do not get caught up in its daily performance and just have fun!