Debunked #2: Gold Is The Best Investment Option

Second post in my investing myths debunked series. The following pertains to physical gold in the form of jewellery or bullion.

The myth that gold is the best and safest investment option is deep-rooted and hard to override. It is tough to convince people otherwise in a gold obsessed nation like India.

Indians are just too fond of their gold. India is in fact the biggest consumer of gold. So much so, that it is a sure bet to say that gold in one form or another – be it jewellery or coins or bars – can be found in each and every household of India.

In India, there are 2 main reasons for buying gold:

1) First is more traditional and cultural than anything else -demand for gold in form of jewellery. Come a festival like Dhanteras or wedding season, & the demand for gold will increase further.

2) Another reason is that gold is a liquid asset which can be bought without much research or knowledge & transactions can happen almost instantly. Also, it can be easily hoarded without paying taxes – although that is changing now as you have to provide your PAN card while buying gold for 200,000 or more.

The above two factors can be held responsible for the fact that 11% of total Indian household wealth is being invested in gold as per the latest report of Reserve Bank of India.

Now, the problem arises when people try to justify this craze for the yellow metal by convincing themselves that gold is the best and safest form of investment, and will help in the future as its value always increases.

Lets try and understand why this belief is wrong:

  • Safeguarding gold is a hassle
    It is too much of a hassle to store your gold jewellery or bullion. It can easily be stolen so you have to buy a safe or rent a locker. Some banks ask you to open a fixed deposit if you want to rent a locker. Also, because gold is so much concentrated wealth in such a small package, it is easy to loot. One thief can snag all your gold in just one pocket. Even cash is more difficult to steal than gold. One little bar of gold would be equivalent to wads & wads of cash. Wearing jewellery is dangerous too – Indian metro cities are rife with chain-snatching bike gangs who will yank a gold chain from your neck as you are walking on the street.
  • Gold is a cyclical instrument
    Gold prices depend on market conditions and demand and supply. It will go up if markets are not performing well and people are losing confidence in the financial market. It will go down during bull run of market, because people want to invest in equities and not gold. Also, during high demands, gold price can form a bubble and if bought during this stage, buyer can suffer severe losses after the bubble bursts. Therefore to assume that gold always performs well or its price only increases is totally wrong. You are only setting yourself for disappointment and nothing else if you believe in such myths.
  •  Gold doesn’t always give highest returns
    Indians find it hard to believe that gold can ever generate poor returns. This is because, they tend to compare gold prices during different times but ignore the actual annualized rate of return. But the fact is that gold has not performed well in the last few years when compared with other asset classes. Let’s compare the last 5 years (January 1, 2012 to December 31, 2016) annualized return between different asset classes:
    Equity Mutual FundGovernment SecurityGold
    12.9%10.2%1.7%

    SourceClearly gold is the worst performer among these 3 classes. Apart from better returns, equities and most government securities are more tax efficient investment vehicles than gold. But people still treat gold as the safest investment option and are wary of investing in financial markets. The main reason could be that gold prices are less volatile when compared to equity markets, thus creating a false image of stability and safety. This risk/return perception is main factor for a high demand of gold.
  • Gold is not a productive asset
    If you buy shares of the right company, it will innovate. It will hire the best, it will create products or services that people need or want, it will create wealth for the promoters & shareholders as it tries to outdo competitors & strives for better revenues & better profit margins year after year.

    “When we took over Berkshire, it was selling at $15 a share and gold was selling at $20 an ounce. Gold is now $1600 and Berkshire is $120,000.”
    – Warren Buffet.

    But gold does not “grow”. If you purchase a gold coin when you’re 21 it will still be one gold coin when you’re 71. It won’t become 2 coins or 3 coins over time. Sure it’s value may change but there is no “growth”. It’s value increased not because of the actions of the smartest & the brightest people doing the best work in their field but because of the opinion of the people buying and selling gold. Let’s put it this way, gold is never going to create the next iPhone or the Model S!

If Indian households redistribute even a small amount of their investment from gold to financial instruments, they can increase their net worth easily.

RBI said in its latest report “Households can earn substantial ongoing income gains from these movements. When capitalised, the real present value gain from re-allocating to financial wealth from gold translates into average movements up the Indian wealth distribution of between 0.2 and 4.9 percentage points (pp).”

But if you still want to invest in gold due to prejudice or some other illogical notions, at least opt for paper gold instead of physical gold. Buying gold jewellery as investment just doesn’t make sense, because it includes high making charges of around 10% to 20% which result in you paying way more than actual market price.

You can opt for Gold Mutual Funds or Gold ETF which reflects actual gold price & add a layer of diversification to your portfolio. But if you can lock in your money for 8 years, Sovereign Gold Bonds will be the best option for you. Government keeps issuing such bonds from time to time, and in addition to reflecting actual gold prices you also get additional interest of 2.5% p.a. under this schemes, and the best part is gains are completely tax free.

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