Creating investment portfolio for buying gold

An alternative to investing in physical gold is to buy gold ETFs; they are easier to transact and cheaper to store. Besides, they can act as a hedge and be sold when required to buy gold ornaments.

It is customary among Indian households for parents to gift gold to their daughters during their wedding. The demand for gold increased significantly in 2010, despite the sharp increase in price levels. This captures the relevance of gold in Indian society.

For those investing in gold with a time horizon of 5 years or more, buying gold jewellery at present for future consumption may not be ideal, as fashion and preferences change with time. The question is: Can an investment portfolio help such individuals better manage their goal of gifting gold?

This article shows why an investment portfolio can fulfil this goal better. It then discusses why such a portfolio should hold some other assets, besides physical gold and gold ETFs.

INVESTMENT FACTORS

Individuals typically invest in physical gold — either in its pure form or in the form of ornaments. Physical gold does not, however, satisfy two important attributes that an investment asset should possess.

One, the yellow metal does not generate income returns. Now, investment assets typically have two sources of return — income return and capital appreciation.

Depending on a single source exposes the investor to high risk. Of course, it can be argued that equity investment today is primarily dependent on capital appreciation, as dividend yields are negligible.

True, but an investor still has the choice of buying high dividend-yield stocks; that choice isn't available with physical gold investments. And two, gold isn't a liquid asset. By liquid, we mean investors cannot sell gold with the ease and convenience with which they can sell stocks.

Besides these issues, there is another practical problem. Storing gold is costly, compared with that of financial assets. All these ought to deter individuals from buying the yellow metal.

Yet, individuals buy gold because of a behavioural bias that refers to the good feeling that an individual experiences from buying gold. And this feeling moderates the risk associated with such investments.

Given the issues related to holding physical gold and the individuals' desire to eventually hold the yellow metal, we ask the question: Can an investment portfolio help individuals' reach their gold goal?

INVESTMENT PORTFOLIO

An alternative to investing in physical gold is to buy gold ETFs; they are easier to transact and cheaper to store. Besides, gold ETFs can act as a hedge — individuals can systematically invest in such ETFs and sell them when required to buy gold ornaments.

We, however, believe that a portfolio containing equity, bonds besides physical gold, and gold ETFs would be ideal. Why? Individuals have multiple goals during their lifetime. The investment capital is, however, a constraint. This means that goals have to be prioritised. Sometimes, individuals sacrifice near-term goals because of the need to focus on the more important intermediate goals, only to find later that both goals could have been met!

Suppose an individual wants to have a vacation after three years but has to also meet his child's college tuition fees six years hence. Having to prioritise goals, the individual may forego the vacation and create a portfolio to pay for the tuition fees.

But six years hence, he may well be able to pay the fees from his then current income. While the investment portfolio created for the purpose can be used for another goal, the vacation was unnecessarily missed.

It is, therefore, useful to create target portfolios that can address at least two goals. Our suggestion to create a portfolio containing equity, bonds and gold should be viewed in this context.

CONCLUSION

A portfolio containing stocks, bonds, physical gold and gold ETFs forms an integral part of an individual's lifecycle needs — in this case, meeting intermediate goals, such as child's education and marriage.

Creating an investment portfolio custom-tailored to achieve multiple goals requires more effort, but moderates issues relating to goal prioritisation.

Holding physical gold feels good; buying gold ETFs provides excellent hedge. And including exposure to stocks and bonds along with physical gold and gold ETFs could be ideal within the context of lifecycle investment.

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