Panning for gold is a popular tourist activity here in Arizona.
Gold has mesmerized human beings for thousands of years. In fact, we have an almost innate belief in the tremendous value of this shiny yellow metal. So, it's not surprising that when financial markets go through rough times, many people take on the attitudes of Olympic athletes. In other words, they "go for the gold." Unfortunately, their dreams of wealth frequently get tarnished, because gold is not the "sure thing" that some might expect.
Generally speaking, two key factors stir up investors' interest in gold:
- Political or economic turmoil. Wars and financial crises make people very nervous about investing in the stock market. When that happens, stock prices can fall. As a result, many investors want to put their money in an alternative they view as more stable -- such as gold.
- Rising inflation. Many people look to gold, along with other "hard assets," such as real estate and art, as a "hedge" against inflation. In other words, these investors expect the price of gold to rise along with that of other goods and services.
But is gold really an appropriate alternative to stocks? And is it the best inflation hedge available?
The answer to both these questions is "probably not." In the first place, gold is a commodity, just like grains, livestock, oil and currencies. And like all commodities, gold will rise in value, sometimes quite dramatically, when demand for it increases, relative to supply. But gold prices, like stock prices, can also drop quickly.
Furthermore, although history doesn't always repeat itself, gold has a far worse performance history than that of some other investments, such as common stocks. In fact, on an inflation-adjusted basis, gold trades at roughly the same price as it did in 1833. By contrast, from 1926 through 2004, large-company stocks have recorded an average annual return of more than 10 percent, compared to the average annual inflation rate of around 3 percent for that same period, according to Ibbotson Associates, an investment research firm.
And even as an inflation hedge, gold is almost certainly not the best choice. As alternatives, you could invest in short-term Treasury securities or other short term alternatives money market accounts, both of which would/could benefit from higher short-term interest rates if inflation starts picking up.
Skip the "gold rush"
Clearly, gold should not be looked at as a "cure-all" for investors who are nervous about political instability, shaky financial markets and rising inflation. So, instead of socking away those gold ingots, what steps should you take to improve your investment outlook during difficult times?
For starters, don't panic. The more experience you gain as an investor, the more you will realize that there's very little new under the sun. Wars, elections, oil shocks and corporate scandals are all unsettling events, but they're also recurring ones. As a smart investor, you shouldn't rush to find a "quick fix," such as gold, every time a negative headline appears in the paper. Instead, follow tried and true principles: Diversify your holdings, buy quality, and hold your investments for the long term, or at least until your needs change.
These guidelines may not be as glitzy as gold, but, in their own way, they still sparkle.
-- Scott Flake is a licensed investment representative with the firm of Edward Jones. For more information, call (928) 468-1470.