Saturday, 21 February 2015

Why I Hold Gold in my Portfolio

In my experience if you’re discussing UK Equities as part of an investment portfolio its validity is unlikely to be challenged and any response is likely to be fairly passive.  A typical response might be something like what percentage allocation do you have.  If you say to somebody that you hold Gold then the responses can be far more variable.  At the extreme they can range from I don’t believe in Gold as an investment as it doesn’t pay a dividend because it just sits there looking shiny to I’m 100% invested in Gold, guns, ammo and tinned beans.

Within my own portfolio I target a holding of 5%.  So why do I hold gold?  It’s for the same reason that I buy property or gilts on top of my equities.  To quote Bernstein’s The Intelligent Asset Allocator it’s simply because ‘Dividing your portfolio between assets with uncorrelated results increases return while decreasing risk’ which is a key concept within Modern Portfolio Theory (MPT).  Bernstein continues with ‘Mixing assets with uncorrelated returns reduces risk, because when one of the assets is zigging, it is likely that the other is zagging.’  The keyword in the first quote is uncorrelated.  In the book he works up some examples to validate these statements.

Let’s run a simple analysis looking to see if we can find an example of gold being uncorrelated with another asset class.

My first chart shows how the Monthly Gold Price in Pounds Sterling (£’s) has changed since 1979.  Over the past year its Price has fallen by 0.6%.  We looked in detail at the FTSE100 last week so let’s use that as a different asset comparator as that dataset is up to date.  Over the past year the Price of the FTSE100 has risen 7.0%.

Gold Priced in Pounds Sterling (£)
Click to enlarge

Diverting quickly for completeness, as I always like to show charts in Real terms to remove the emotion that comes with the unit of measure continually being devalued by inflation, let me quickly also show the Real Gold Price in Pounds.

Real Gold Priced in Pounds Sterling (£)
Click to enlarge


Back on track let’s now expand on the return relationship between the two asset classes.  My FTSE 100 dataset only goes back to 1993 so let’s plot the annual return of the FTSE 100 to Gold Priced in Pounds Sterling (£) on monthly increments.

Yearly Price Change in UK Equities (FTSE100) vs Gold
Click to enlarge

Even over this young dataset I can see a number of examples of one zigging while the other is zagging.  The correlation of the annual return of Gold Priced in Pounds to the annual return of the FTSE100 is actually -0.261.  This is a weak negative correlation.  So the two are not perfectly uncorrelated but the correlation is weak.

So does this Modern Portfolio Theory lark really work? As regular readers will know I'm not an investment professional but what I can say on the matter is that 7 years in to my DIY ride to Financial Independence my diversified portfolio of different asset classes doesn't keep me awake at night, nor cause me to buy/sell frequently, while at the same time has provided me with an annualised real return after inflation of 4.1%, so it’s working for me.  That said you also don’t have to go far to find detractors.

Finally, given I'm looking for a 5% Gold allocation let’s look at my current allocation within my portfolio.   Increases in the stock market, falls in the price of Gold and some new money entering the portfolio which hasn’t been invested in gold means that my Gold allocation is now down to 4.4%.  In percentage terms I’m 12.8% underweight which is my second most underweight asset class after cash.  A top up could soon be on the cards which will be a novelty given my last Gold investment was a purchase back in February 2014.

As always DYOR.

Assumptions:

  • Gold prices are monthly averages except February 2015 which is the spot price at time of writing
  • FTSE 100 prices are closing prices of the first day of every month except February 2015 which is Friday’s closing price

30 comments:

  1. RIT,
    Could you share the yield of your portfolio for the whole duration?
    Assuming all your cash contribution were growing with the same continuous rate R, what is that R?
    Basically, if Ki is i cash contribution, Ti - number of years since then, then sum(Ki * exp(Ti * R))=PV, where PV is ghe present value of your portfolio. One can get R in a few iterations in Excel.
    Thanks
    K.

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    1. Hi K.

      I think I can get the yield for the whole duration. My Excel history is structured on an annual basis and to account for new money I just use XIRR to calculate an annualised rate for each year. I have all of those from 5 Jan 2008 so am only missing the return from a few months as I essentially started in October 2007. I'm stopping at 7 February 2015 as I only calculate XIRR on a YTD monthly basis. Compounding those up for the total duration and the total yield has been 60.1%.

      Hope that was what you were meaning?

      Cheers
      RIT

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    2. This is total, but what what is yearly rate?
      In other words, imagine that you have got a fixed (continuous) rate R saving account which you can add money any time. If this fixed rate account is contributed to the same as your fund and now has Present Value as your fund then - what is that rate R?
      K.

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    3. R=6.9%. This is effectively my portfolio CAGR.

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    4. This is pretty good return. I think this can serve as a measure of how good one in stock picking.
      K.

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    5. As you know I'm not doing a lot of direct stick picking - only the HYP portion of my portfolio. The portfolio also contains plenty of cash and NS&I index linked savings certificates which are dragging on performance but protecting my cash in real terms in readiness for an eventual home purchase.

      The vast majority of the return has come from a diversified portfolio of tracker assets, which are rebalanced if they get out of whack by 25% and then new money buying the worst performing asset class. On top of that a little bit of asset allocation shift based on equity valuations.

      I'm genuinely happy with how it's going. I never wanted to knock it out of the park. When I started I was chasing a real 4% annually over the very long term. Seven and a third years later and I'm at 4.1%.

      Do you keep the return for your portfolio?

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    6. Thanks for the post, RIT, as always. Does RPI include house prices? Is that what 'house depreciation' is? Do you think that where you are going to want to buy property is being fairly valued in the RPI figure? (I know that local variation is huge in the UK, and that you may be thinking Italy/Malta).

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  2. 5.9%. Not sure I understood that 4.1 rate, this with cash?

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    1. The 4.1% is a Real after inflation figure. Portfolio CAGR of 6.9% as above and Inflation (RPI) CAGR of 2.8% -> a Real 4.1%.

      I can't remember what your asset allocation looks like and I can't find the post where I think you shared a bit more about your investment strategy. Trying to understand how I'm 1% up as we talk about a lot of common asset classes. Asset allocation maybe? Do you know what your worst performing asset class has been? Also could be timing. What date are you counting from?

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    2. Well, this is your blog not mine:) I go along with your desire to get some discussions in comments to a degree.

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    3. Fair enough and no problem as your contribution is already valued. But... I've also never claimed I'm right or don't have any more to learn. I also don't know what the future holds for which everyone brings an opinion. For all I know I'm sleep walking into a disaster. That's why most times I value the Comments discussion more than what I learn before making the investments I post about.

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    4. Actually, my R =8.2.
      Just found out that pension provider had some lag in posting valuations, so my previous number was not right. Such a relieve, it is now where I approximately expect it to have.
      If u are curious, my duration 5 years, this is the breakdown:

      global emerging = 30
      asia, high risk = 12
      small caps =10
      corp bond = 6
      europe =8
      UK + developed =17
      US + developed =17

      K.

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    5. Thanks for clarifying. If I compare my 5 year performance (2 Jan 2010 to 3 Jan 2015) I'm at 7.9%. Going from 2 Jan 2010 to 7 Feb 2015 I'm at 8.6%. Depending on your exact starting and finishing dates it looks like my methods have me either slightly ahead or slightly behind.

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  3. I choose to follow the permanent portfolio strategy after 2008 showed me that I didn't have the stomach for a stock heavy portfolio. Of the assets that make it up gold is the one that I have found quite difficult to buy.
    I hadn't hit a rebalance band until recently when some my Gilts were redeemed. So now I have hit a rebalance band via cash and on the face of it most of it needs to go to Gold... and I find myself prevaricating.
    Even with a solid mechanical strategy the fear of shovelling some of your safe asset into one you perceive to be currently unsafe is surprisingly hard to do. I expect I'll get rational about it soon, but right now It feels like I've got one foot hanging over a cliff edge. I thought diversification was the easy option :)

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    1. Interesting.... a lot of people would say physical gold was the safest thing money could buy from the point of view of peace of mind. It just depends on your view of the current financial system and future risk analysis, I guess.

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    2. Thanks for sharing Nathan and good luck with the courage to pull the trigger.

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  4. Hi Jim F

    TBH I've pretty much given up on buying a home in the UK. I haven't even updated my UK housing datasets for a long time now. I know what I'm going to see - they're probably still affordable because of super low interest rates but they certainly won't be good value. Annually I usually run a big analysis down to County level but I'm not sure if I'll even do that this year. We'll see.

    Having spent some time in the heel of Italy this winter to try and get a better idea of life there my family is currently thinking Italy is probably not for us. Malta (or Gozo) is however still very much on the cards having spent all seasons there over the past few years.

    Cheers
    RIT

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    1. Well done for trying a bite.

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  5. Hi RIT,

    Thanks for the interesting blogs. I have followed you for a while after taking control of my finances about two years ago and many mistakes later. I have no gold in my portfolio, but this is certainly food for thought.

    I have a slightly off topic question. I'm still unsure about calculating real annual returns in my portfolio after inflation. I have a Hargreaves Lansdown account and they give me the percentage rate of the whole portfolio just like any other funds supermarket. Do I just compare this PR to the previous year's PR and then minus inflation to give me a comparable total return. It would be nice to have a graph of my real growth year to year after inflation (similar to what you have done in other blogs). Do you feel like sharing how to do this kind of thing in the simplest way possible?

    N.B I invest all my dividends into the same IT's and Indexes the dividends come from.

    Many thanks

    Steve

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    1. Hi Steve

      For a single year you just look at the return in the year of interest (%) and minus the rate of inflation in the year of interest (%). My preferred rate of inflation is the RPI. So let's say your portfolio returned 6% and the RPI was 1% your real portfolio return was 5% in that year.

      If you want to correct a complete dataset for inflation (like I've done above for Real Gold) this is the method I use in Excel. Real Value of Interest =B1*$A$2/A1 where B1 is the Value of Interest, A2 is the Current Inflation Index Value and A1 is the Inflation Index Value at the time of the Value of Interest. Note the inflation numbers are index values and not %'s. You can then just fill down to calculate all Real Values.

      Hope that helps.

      On the subject of mistakes. Having now been DIY'ing for some time I'm starting to think that the person who hasn't made any mistakes either isn't learning or is a liar.

      Cheers
      RIT

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    2. Thanks for your reply.

      I will give it go and see how I do. I want to make a "working for the man" type graph because I know the target I will need to reach before I have financial independence. I also think it focuses the mind on the end goal.

      Keep up the good work.

      Steve

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  6. I've yet to be convinced that diversification for diversification's sake is the no-brainer it's cracked up to be. Given that equities - long-term - tend inexorably and enthusiastically upwards, I'm not sure I want *any* uncorrelated assets.

    Plus, gold tends to be the preserve of paranoid schizophrenic nutjobs preparing for the zombie apocalypse (though what use it'll be to them then I can't imagine). RIT remains a rare exception!

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    1. Hi Simon

      Have you read the Bernstein book that I referred to above? Of course you need to form your own opinions but I'd really suggest reading it before writing it off. It's a few years old now but it does a pretty nice job of demonstrating how the free lunch works.

      Within my own portfolio I can see examples where I have definitely achieved a free lunch.

      "...the preserve of paranoid schizophrenic nutjobs preparing for the zombie apocalypse..." As I said in the post "the responses can be far more variable". :-)

      Cheers
      RIT

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  7. Similarly I'm also not convinced about gold, but as part of a 5% it also wouldn't hurt. Part of my problem is the bid ask spread on most etfs is quite big and etf fees aren't low,so together they eat up quite a lot of costs which is against our shared philosophy on keeping costs down. If you buy physical the bid ask is crazy and is really an armageddon play which istoo eextreme for my taste. How do you buy your gold RIT?

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    1. Hi Jaks
      If you go back a couple of posts you will see the investment products I'm currently using for my complete portfolio. When it comes to gold I'm currently holding via ETFS Physical Gold.
      Cheers
      RIT

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  8. @Jaks

    I hold gold as 1 ounce brittania coins. Althougth there is a significant premium to 'spot' gold prices per ounce, they have the advantage of being (currently) CGT free and VAT free.

    So handy to keep outside an ISA (and not use up the allowance) but not so good for a SIPP, of course. Quite liquid too. I bought mine from Bullion by Post who will buy them back at a modest discount to their current price.

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    1. How do you store them?

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    2. yea... and could you remind your safe combination please?

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  9. Gold: why 5%, RIT?

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    1. The basics of my portfolio was constructed from the Tim Hale book which you can find under the 'Books that Helped' tab above. I would really recommend that any reader who is UK based must read at least this book before doing any DIY investing. It was a life changing read for me.

      The % to gold really just fell out as part of that portfolio construction, which you can find under the 'My Low Charge Portfolio' tab and then click on 'The Retirement Investing Today Low Charge Strategy' hyperlink.

      An important point for me was that the %'s are actually an imperfect science.

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