The Connection between Risk Tolerance and Gold
Posted onOne of the most important questions for any investor is how much risk are you comfortable with? In investing, risk can be defined as:
- The permanent loss of your money or
- Not having money when you need it.
Both outcomes are undesirable to say the least.
Stocks are considered one of the most risky asset classes. Stocks tend to be more volatile than bonds and can deliver a higher expected return. But in exchange, stock investors take on a greater risk of loss. So, if you have 80% of your portfolio invested in stocks that is considered to be a fairly aggressive or highly risky level.
Risk tolerance measures how much risk you are willing to take on. To consider your own risk tolerance level ask yourself these questions:
- What are your investing goals?
- How soon will you need your money?
- How comfortable are you with losses?
Considering your feelings around portfolio losses is an important consideration. There have been 28 bear markets since 1928, with an average stock market decline of 36%.
However, some bear markets in stocks have been much worse—for example, the 2008 financial crisis saw a 51.93% decline in the stock market. That means if you had a one million dollar portfolio you’d have lost roughly half of your total investments. You’d have watched your million dollar portfolio sink down to $500,000 during the 2008 stock market crash.
While you can’t control the stock market, you can mitigate some of your risk with an allocation to gold.
Gold serves investors well on three key fronts. Gold provides risk management, capital appreciation and wealth preservation. Indeed, gold doesn’t just diversify your portfolio and protect your wealth—it can also help you grow your wealth. Over the past twenty years, gold has returned an average of 8.34% annually.
How much gold should you own? This depends on your risk tolerance level, your investing goals and your time horizon. But, research shows that holding between 2% and 10% of your total portfolio in gold improves portfolio performance (better returns) and reduces total portfolio losses (lower drawdowns) compared to a portfolio that doesn’t hold any gold.
Best Returns for Portfolios with 10% Allocation to Gold
Portfolios containing a 10% allocation to gold saw the largest annualized and cumulative returns, with the lowest maximum drawdown, according to State Street Global Advisors.
Today, amid warnings of an overvalued and frothy stock market, it’s worth considering if you have enough wealth protection right now. If not, the research shows that adding more gold to your portfolio is a proven solution and can help you take some of the investing risk off the table.
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