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Want to Increase Your Profits and Lower Your Risk at the Same Time? Think Precious Metals

by Jason Dean 


gold2Historically, gold has been a store of value and the ultimate hedge against economic calamity. As the old Wall Street adage goes, “Put 10% of your assets in gold and hope it doesn’t work.” A recent study by Ibbotson Associates indicates that even in the absence of economic catastrophe, allocating a chunk of your portfolio into gold, silver, and platinum has worked, while simultaneously reducing your exposure to risk.

Portfolio Diversification

Everyone knows that diversification is an important element of investing. Most people consider “diversification” to be a good mix of stocks across multiple sectors, or perhaps a mix of stocks and bonds. But the truth of the matter is, in the thirty-plus years since the U.S. went off the gold standard, stocks and bonds have traded relatively in tandem, whereas gold, silver, and platinum have been counter-cyclical to stocks.

The Sharpe Ratio is a measure of an investment strategy’s risk-adjusted returns. In other words, it takes two things into account: 1) The profits or losses generated, and 2) The risk assumed by the strategy. The greater the return and the lower the risk, the higher the Sharpe Ratio. A recent study by Ibbotson Associates found that a “moderate” (as opposed to “conservative” or “aggressive”) portfolio without gold, silver, and platinum, had an expected return of 8.6% per year, with a Sharpe Ratio of 0.437. But by allocating 12.5% of assets into gold, silver, and platinum, the expected return was boosted to 9% and the Sharpe Ratio increased to 0.472. This data is based on historical performances, 1972 through 2004.
Recommended Asset Weightings

For a moderate portfolio, Ibbotson advises investors to make the following allocations:

  • 20.4% U.S. large-cap stocks
  • 12.7% U.S. small-cap stocks
  • 19.7% international stocks
  • 12.5% Spot Precious Metals Index (SPMI) — equal parts gold, silver, and platinum bullion
  • 8.2% long-term U.S. government bonds
  • 21.1% intermediate-term U.S. government bonds
  • 5.5% 90-day U.S. Treasury bills

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Comments

2 Responses to “Want to Increase Your Profits and Lower Your Risk at the Same Time? Think Precious Metals”

  1. Silver Monthly on August 11th, 2007 1:39 pm

    “expected return was boosted to 9%” isn’t that lower than the average return of the S&P 500? I think the S&P 500 gets an average return of 11%.

  2. Jason Dean on August 13th, 2007 1:27 am

    Yes, you are correct, but investing in the S&P is much riskier than investing in a diversified asset mix, including gold and silver. The Sharpe Ratio is a measure of return over risk, and it’s important because even though it may seem better to invest in the S&P with an 11% return, your time horizon has to be infinite (or at least, very long) to be confident in that return. For example, from 1971 to 2004, gold-silver-platinum was a better investment more years than the S&P was. If you invested in the early seventies with a horizon of ten years, the S&P would have been a very bad investment for you. A diversified asset mix of stocks, bonds, cash, and precious metals provides the best risk-adjusted return; at least, historically speaking.

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