You've heard the term "gold bug." It's used to describe someone who is bullish on the bright, shiny, heavy yellow metal that is part of the commodities asset class.
Gold bugs concern me. Here's why:
They always seem to feel that the world is coming to an end and as a result, believe a huge proportion of their assets should be weighted to the precious metal asset class, specifically gold. They simply don't believe in a well-diversified portfolio.
Precious metals and their value tend to be tied to the U.S. dollar. When the value of the U.S. dollar declines, precious metal prices typically increase. Many gold bugs feel that with the huge deficits being racked up by government spending, and the Federal Reserve's current policy of keeping interest rates low, the dollar will continue to decline and inflation will spiral out of control.
Maybe all of that will happen, but that does not mean an investor should be over-exposed to the precious metals asset class In fact, a prudent investor should not be over-exposed to anything, whether it'scommodities (including, but certainly not limited to precious metals), stocks, bonds, cash, or real estate.
But what will a gold bug say? They will say that you should overweight it—big time. And that's the problem.
Do I think there is room in investors' portfolios for exposure to that asset class? Sure, just like I think there is room for a little bit of anything in everyone's portfolio. But every investment plan should be the function of a complete and comprehensive financial plan and any financial plan matching that description will not be over-exposed to any asset class.
[See What's Next for Gold?]
I took a look at J.P. Morgan Asset Management's quarterly Guide to the Markets recently and reconfirmed a fact I had heard a long time ago. Gold, on an inflation-adjusted basis, has not reached the same peak it achieved in 1980. Consider this: If you traded in a Rolex watch for a bar of gold in 1980 and then sold that bar of gold today to get back your Rolex, you would not have enough money.
Now that would bug me.
And here's something else. If there is some sort of national or global crisis that plays out from some doom-and-gloom scenario, I'm willing to bet that a box of Ritz crackers and a can of Cheez Whiz is going to be worth more than that ounce of coins in a desk drawer.
Final point: The precious metal asset class has no cash flow and no earnings. It's only worth what someone else says it's worth. Period.
On the other hand, equities are priced based on, among other things, cash flow and future earnings. If you put $10 in the Dow Jones Industrial Average on Jan. 2, 1980 and left it alone, hypothetically it would have increased more than 1,300 percent.
That 10 bucks would have grown enough to buy 2 or 3 Rolex watches at $5,000 a pop. With inflation running at a historical rate of about 2.5 percent, that's what I'd call some good inflation protection.
The commodity asset class, including precious metals, has done well recently (as measured by the Dow Jones Precious Metals Index). Like I said, if you want a little commodities exposure in your portfolio, there is probably room. And there is no question precious metals, such as gold, hold their value. For example, back in the late 1800s, an ounce of gold would buy you a really nice suit. In 2010, guess what you can buy with an ounce of gold?
A really nice suit, and a can or two of bug spray.
David B. Armstrong , CFA, is a managing director and cofounder of Monument Wealth Management in Alexandria, Va., a full-service wealth management firm. Monument Wealth Management is backed by LPL Financial, the independent broker-dealer and Registered Investment Advisor. David has been named one of America's Top 100 Financial Advisors for two straight years by Registered Rep Magazine (2009 and 2010 based on assets under management) and has been interviewed by several national media sources for the past several years. David and Monument Wealth Management can be followed on their blog "Off The Wall," their Twitter account @MonumentWealth, and on their Facebook page.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. The Dow Jones Industrial Average index is an unmanaged index and cannot be invested into directly. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk. The fast price swings of commodities will result in a significant volatility in an investor's holdings. Stock investing involves market risk including loss of principal. Securities and financial planning offered through LPL financial, Member FIRNA/SIPC.