Investors Deserve Equal Pay


Posted in: Economics, General, Stock Market, Thought of the Week

Short-term volatility is a measure of emotion, and equities are considered to be one of the more volatile asset classes. Those who have experienced the weekly and even daily swings in the S&P 500 over the past decade need little evidence to support this notion.

What may actually come as a surprise to many is that gold is actually slightly more volatile than the S&P 500. The table below compares the volatility of each over various time periods going back to 1980.

gold volatility

 

 

It’s important to remember that volatility is not always a bad characteristic of an asset class. In fact, volatility in equities is a long-term investor`s best friend because panic selling opens up wonderful buying opportunities for those who are patient.

However, if an investor is going to be forced to endure volatility, then he/she should expect a higher return over time compared to an asset class with less volatility. Furthermore, two asset classes with equal volatility should also pay investors the same.

Simply put, investors should be paid commensurate to the level of volatility within an asset class. If two asset classes have comparable volatility but different expected returns over a multi-year period, then investors are best suited to avoid the inferior of the two.

Implications for Investors

Warren Buffett gave a speech at Harvard back in 1988, where he famously shot down gold by saying: “It gets dug out of the ground in Africa, or some place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

To his point, gold produces no cash flow or earnings, so it cannot reinvest back into itself in order to grow over time. Gold pays no dividends, and investors have no opportunity to compound returns, which is one of the most powerful ways to create wealth over time.

The bottom line is that gold has been a poor long-term investment, given its volatility, and will most likely continue to have subpar returns versus equities over the next decade. Therefore, owning a small position of gold as a hedge against inflation in a diversified portfolio is fine, but I strongly recommend keeping the allocation below 10%.

Read this week’s Thought of the week to learn more about volatility and how it affects gold.

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As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.