Why Portfolio Diversification is a Must

By Best 5 Gold IRA Companies on July 19, 2023   /   Gold IRA Articles  

Unfortunately, stability is a rare quality in investment markets today:

• Stocks. The stock market is increasing its volatility – the amount of up and down price movement – Increasing investment risks and exerting pressure on investors to accurately time their buys and sells. A single misstep can have a calamitous impact on a stock portfolio. The S&P has established a new normal of volatility.
• Bonds. Long-Term Government Bond yields have trended downward for the past forty years from a high of 15.32% in September 1981 to 1.47% in December 2021 due to lower inflation rates. As higher inflation rates recur, bond yields increase, and the value of outstanding bonds with lower interest rates drops in price.

An Era of Increased Investment Risk

Covid variants threaten economies worldwide, international supply chains are hopelessly tangled, and global tensions are rising.

Governments are borrowing funds and printing money at an unprecedented rate while high inflation rates have reappeared (The U.S. Consumer Price Index increased 8.3% as of August 2022, the most significant gain since 1982).

Uncertainty is especially worrisome for retirement savings due to their importance and limited duration. Older investors have fewer investment years to recover from a significant loss in portfolio value.

Every year since 2000, the stock market has experienced declines from 2.6% (2017) to 47% (2008).

In uncertain times, investors should remember the words of author Robert Kiyosaki (Rich Dad Poor Dad): “It's not now much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.”

Portfolio Diversification Has Been Accepted to be the Number One Strategy to Manage Risk

Spreading risk over various financial instruments with differing characteristics – diversification – has been a popular investment strategy for years. Concentrating capital into a single investment type or security is a high-risk strategy, exposing investors to substantial losses if their expectations are false. Extreme price movements – volatility – subject asset owners to sudden stress and knee-jerk reactions with negative, long-term impact.

Portfolio diversification moderates volatility, reducing stress and the temptation to overreact to an asset's or asset group's volatility. Unsurprisingly, a balanced, diversified portfolio is more likely to outperform a concentrated portfolio long term.

Successful portfolio diversification requires a combination of assets whose price actions are negatively correlated, i.e., when one goes up in price, the other falls in price. For example, equities and fixed-rate instruments (bonds) typically react differently, so when interest rates fall, stock prices rise, and vice versa. The goal of a balanced, diversified portfolio is to produce a long-term maximum gain while being exposed to the least amount of potential loss (risk).

Gold – Portfolio Diversification and Protection

Investment professionals at the…

• Motley Fool (“When capital markets are in turmoil, gold often performs relatively well as investors seek out safe-haven investments.”) and…
• Yahoo Finance (“Gold has a knack for retaining value, and it is especially popular during downturns when it typically performs well as an investment. For some reason, humans place value in the tangibility and allure of gold, like Gollum to the ring.”)

…are fans of gold investments during perilous times. Investors tend to push up the price of gold when financial markets are volatile.

Gold has maintained its purchasing power over a vast span of history, and that is not likely to change.

Gold investments have performed exceptionally well during periods of monetary crises and stock market declines:

• Rising government deficits. Jared Dillian, author of Street Freak: Money and Madness at Lehman Brothers, writes, “The price of gold also goes up when the federal deficit grows, as it's doing now.”
• Stock market declines. The price of gold typically moves in a contra direction to the stock market. Between November 30, 2007, and June 1, 2009, the S&P 500 index fell 36% while the price of gold rose 25%. When they move in the same direction, gold prices move in lesser proportions than the stock market.

Physical Gold or Gold Substitutes

Investors have choices in the form of gold investments today. The traditional form of gold is the physical metal, typically bars or coins of 99.9% purity. Investors can also purchase:

1. Equity in a gold mining company.
2. Shares of gold mutual funds or ETFs.
3. Gold futures and options.

In each case, the asset is indirectly related to physical gold or its value. Consequently, non-physical gold substitutes do not provide the portfolio diversification impact of physical gold.

Gold Ownership: Director in a Self-directed IRA

Many investors choose to personally invest in gold, taking possession and storing it in a home safe or local bank safety deposit box. In such cases, the metal is readily available at any time. Personally owned gold is subject to tax laws like other investments, i.e., income tax is due on any profit between purchase and sale. Personal gold diversifies an investor's total risk even though it may be separate from a stock portfolio or a government-sponsored retirement account.

Many investors seek the tax advantages of purchasing gold in an Individual Retirement Account (IRA). The legislation creating IRAs overlooked this need initially but amended to allow physical gold in self-directed versions of traditional and Roth IRAs. Investors with established IRAs can also transfer cash to a self-directed IRA directly or through a rollover IRA.