One of the questions I am asked regularly is: How much of my investment portfolio should I hold in gold and silver?
For many years, the standard answer from financial advisers has been somewhere around 5% to 10% of a diversified portfolio. There is nothing inherently wrong with that approach, but I have always felt that it is too generic. Why should the appropriate allocation to precious metals be the same for an investor living in Switzerland, South Africa, Australia or Argentina? More importantly, why should it remain the same when the economic and political environment around that investor changes?
I prefer to look at precious metals through the lens of risk.
Precious Metals Are Not Just Another Investment
Gold and silver certainly have the potential to appreciate in value, but that is not the only reason I believe investors should own them. Physical precious metals perform a different role from many conventional investments.
I think of them partly as financial insurance.
We insure our homes against fire even though we don’t expect them to burn down. We insure our cars even though we don’t expect to have an accident tomorrow. The purpose of insurance is not to predict that something bad will happen. It is to protect ourselves against the financial consequences if it does.
I believe physical gold and silver can be viewed in much the same way.
They are tangible assets that do not depend upon the continued solvency of a bank, company or financial institution for their existence. They have also historically been used as stores of value through periods of currency weakness, inflation, financial instability and political uncertainty.
The question therefore becomes less about “What percentage should I invest in precious metals?” and more about:
“How much financial insurance do I believe I need?”
Start With Your Own Assessment of Risk
Every country carries its own economic, political, and social risks.
These might include government debt, inflation, currency depreciation, political instability, unemployment, banking risk, capital controls, deteriorating infrastructure, social unrest or broader geopolitical events.
The risks facing a South African investor are not necessarily the same as those facing an investor in the United States, Europe or Australia. Even two South African investors can look at exactly the same environment and reach completely different conclusions about what the next decade might bring.
And that is perfectly reasonable.
Nobody knows with certainty what the next five or ten years will look like. The purpose of investing is not to predict the future perfectly. It is to position your wealth so that you can survive a range of possible futures.
This is where my approach to precious-metals allocation differs from the conventional 5% or 10% rule.
Match Your Precious-Metals Allocation to the Risk You See
As a simple way of thinking about it, imagine that after considering the economic and socioeconomic outlook of the country in which you live, you believe there is roughly a 10% probability of serious disruption to the financial environment over the next five to ten years.
A 10% allocation to precious metals might therefore make sense to you.
Another investor may look at exactly the same environment and believe that the probability is closer to 30%. That investor might be comfortable holding approximately 30% of their investment capital in precious metals.
Someone who genuinely believes there is a 50% probability of substantial socioeconomic or financial turmoil might reasonably ask themselves why only 5% of their wealth is positioned to protect against the scenario they believe has a one-in-two chance of occurring.
At the extreme, an investor who believes there is a 75% probability of severe instability may decide that a substantially larger portion of their wealth should sit in assets designed to protect against that environment.
I am not suggesting that 10%, 30%, 50% or 75% is the correct allocation for anyone. Nor is a perceived 50% risk mathematically proof that exactly 50% of a portfolio should be held in bullion.
Rather, I use this as a framework for asking a much more useful question:
Does the amount of financial protection I own actually reflect the amount of risk I believe I face?
The 5% Rule Can Create a Strange Contradiction
This is where blindly following a standard portfolio allocation can become problematic.
Imagine an investor who is extremely concerned about the future of their country’s currency, government finances and socioeconomic stability. They believe there is a meaningful possibility that these issues will become substantially worse over the next decade.
Yet 95% of their wealth remains exposed to the very financial environment they are worried about, while just 5% sits in precious metals.
There is a disconnect between the investor’s assessment of risk and the way their capital is positioned.
Conversely, someone who is highly confident in the economic, political and monetary outlook of their country may have little reason to place half their investment portfolio into physical precious metals.
The allocation should reflect the risk.
Your Allocation Should Be Allowed to Change
Another problem with fixed rules is that risk is not fixed.
Perhaps you believe the economic outlook today is relatively stable and you are comfortable with a 10% precious-metals allocation. Five years from now, circumstances may have changed considerably.
Your allocation can change with them.
Equally, if risks that previously concerned you begin to diminish, it may make sense to reduce your exposure to precious metals and increase your allocation elsewhere.
This is why I believe precious-metals allocation should be something investors review periodically rather than decide once and forget about.
You are effectively asking:
Has my assessment of the future changed, and does my portfolio still reflect that assessment?
There Is No Perfect Percentage
If you ask ten financial professionals how much gold you should own, you may receive ten different answers.
That tells us something important.
There probably isn’t a magical percentage.
Rather than beginning with an arbitrary rule saying that everyone should hold 5%, 10% or 20% in precious metals, I believe investors should start by thinking seriously about the risks surrounding their wealth.
Ask yourself:
What do I believe the next five to ten years could realistically look like?
What are the major risks to my wealth?
How exposed am I to one country, currency or financial system?
If the scenario I am worried about actually occurs, how much of my capital do I want positioned outside that risk?
And finally:
Does my current precious-metals allocation reflect my answers to those questions?
For me, that is a far more useful way of deciding how much gold and silver to own than simply accepting that everyone, everywhere, under every economic circumstance, should own the same 5% or 10%.
The correct allocation is not a number somebody else can give you.
It is a reflection of the future you believe you need to prepare for.
This article represents my personal approach to precious-metals investing and is intended for general information and education. It should not be regarded as personalised financial advice.
If you have any questions, our team is always happy to help.
