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Financial Planning

The Economic Times Wealth, February 11-17, 2013

15

How much to invest in gold


Let your motivation dictate the share of the yellow metal in your portfolio, says Uma Shashikant

nough has been said and written about gold as an investment option. The latest argument is that the craze for gold among Indian households is endangering our countrys balance of payments. The policymakers are busy trying to find ways of discouraging investment in gold, but if households keep the common good in mind, they would be paying the market price for gas cylinders as they do for, say, their mobile phone bills. After all, private decisions are driven by private motives. So, how should a household look at gold from its own perspective? Gold is primarily acquired for its merit as a store of value. Even if the worst crisis hits a family, the gold that it holds could be put to use anywhere in the world. In fact, this attribute and rationale encouraged the traditional wisdom of adding gold ornaments to a daughters wedding trousseau. This meant that she had her personal wealth to fall back on at any time. Every family needs this buffer, but one should desist from overdoing it. This is because in modern times, a girl childs security of income comes more from her education and career, rather than from the jewels she owns. However, gold is a safety net and this is the role it plays in ones investment portfolio too. This need could be met by a 10% allocation to gold in a familys portfolio. GETTY IMAGES There are two other drivers of investment in gold. The first is the with access to loans and insuraneed to hoard undisclosed cash nce, choose these options over What investors earning. The other is to use gold gold loans. We have now want from the as collateral to borrow money. triggered an auto-demand Budget Both these uses have been cycle, where more gold is Page 10 entrenched in the system due to bought on whim and then used flaws that have persisted for a to raise money as needed. long time. The lack of law enforceIf specific motivations drive a ment when it comes to income households purchase of gold, higher disclosure and tax collection has led to allocation comes from its balance sheet. In large-scale hoarding of illegal income in one case, the skew is due to illegal cash; in the form of gold. The purchase of gold to another, the skew comes from lack of hoard wealth neither requires know-yourstable income. For all other households, customer (KYC) compliance, nor is it allocating too much to gold can be harmful declared as wealth. The ostentatious for long-term wealth. consumption of gold by a class of evaders There are two prime motivations that creates social pressure, which leads to are fuelling the demand for gold. The first other income groups accepting gold and is the attraction to a physical asset that crejewellery as a symbol of status and wealth. ates a sense of well-being. Then there is the Gold is also seen as a source of liquidity, bias from the recent outperformance of prompted by the lack of widespread bankgold as an assetit has beaten equity, proping, investing and insurance facilities, and erty and bonds by a large margin in the the non-inclusion of many households in past five years. the financial markets. It is not uncommon Hoarding gold is a clear case of for those with irregular and seasonal acquiring an asset for emotional rather incomes, be it agricultural labour or urban than financial needs. Such investors casual labour, to save periodically in gold. should realise that gold is an asset that genThis is pledged to generate cash during erates no income while idling; it has to be lean times and recovered when incomes sold to redeem the economic benefit. The go up. Moreover, they pledge their gold to household must have a firm plan to sell the meet a sudden need for cash. Unfortunategold as and when needed since that is the ly, this practice has also spread among main purpose of building assets. From the those with access to banking facilities. The point of view of the latter, pure gold bars ease of transacting, ability to transact in and coins are superior to jewellery. The cash, and less stringent processes have led bottom line? It would be a folly to purchase to a sharp growth in the market for loan gold jewellery and assume youve made a against gold. This is a gap to fill, so those smart investment. If there is no intention

to sell the jewellery when needed, the gold is of as much economic value as a designer handbag costing a fortune. Yes, there is snob value, but little else since both are accessories, not investments. Those who have bought gold swayed by the sharp rise in prices in the recent past have made a tactical asset allocation decision. In the market place, different assets do well at different points of time. So, instead of blindly jumping on the bandwagon, investors need to focus on the reasons that might have caused gold to outperform equity and other assets, and whether those conditions can be expected to prevail in the future. The period after the 2008 global economic crisis was filled with uncertaintylarge investment banks failed, countries defaulted, currencies tumbled and businesses folded. Heightened uncertainty makes gold a safer investment and leads to it being given excess weightage in a portfolio. This, in turn, pushes up its price. The big question now is whether the global uncertainty will continue. Is there new information about new risks in the glob-

al market? If the answer is no, overallocation to gold may be a harmful investment strategy. The trouble in a bullish market for any asset is that the behaviour of prices clouds everything else. The overconfidence is evident when most investors discount any new negative information and focus only on the positive. Those who have ignored the correction in gold prices in the past three months may be doing just that. If you are considering investing in gold, start with questioning your motivation. Are you trying to evade tax? Are you buying for vanity? Or is asset allocation your main agenda? Your answer will dictate how much wealth should be stashed away in gold. Be sure you have a strong reason to increase its share beyond the basic 10% of your wealth.

The author is Managing Director, Centre for Investment Education and Learning.

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