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!

I am in my early 20s, isn't it too early to start saving for retirement?

My niece is in her early twenties and asked me whether or not it is too early to start saving for retirement. To answer her question, I ran some simple calculations.

Let us start with a few assumptions:
Let’s assume that she will not need the money for forty two years (she will be sixty five), that the annual average rate of return on her retirement savings is eight percent, and that the annual rate of inflation is three percent.

Now we can look at two possible scenarios:

She does nothing for the next twelve years, and begins saving at the age of thirty five. She saves $10 thousand per year, and in thirty years she will have saved about $513 thousand. Discounting inflation, that would equal about $150 thousand today.

Or

She saves $2 thousand for the next two years (she will be a starving graduate student and will probably not have more to save); and then $5 thousand per year, increasing for inflation for the next fourty years. In fourty two years, she will have saved about $1,891,000 , worth about $550 thousand today.

In the second scenario, she would accumulate three times more money when compared to the first. It would allow her withdrawing $25-33 thousand a year in retirement relatively safely (in today's dollars). This would be my advice to her for right now.

Is it realistic? I think so. In two years when she finishes her Masters Degree most likely she will find a job that might pay around $50,000. So her retirement contributions would be about 10% from her pay.

Though this may not be enough to allow my niece the lifestyle that she would like to enjoy, it will get her into the habit of saving. It will also give her first hand experience with investing and allow her to see the results. As time goes by, the plan will change. Most likely, her income will grow, her lifestyle will change, her household will multiply, and her assets and liabilities will alter. But overall, she will have a sense of security about her retirement savings and her financial future.

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!