In a previous article, I gave the reasons why I own gold. Those reasons, the performance of gold over the last two decades, the Fed’s massive money printing, the economic stimulus, and the effects of the pandemic on the future price of gold have all influenced what percentage of my portfolio I have allocated to gold. 

Still, diversification is key to the portfolio success of every investor. As an investor and as someone who addresses investors, I am dead against speculating with large portions of your portfolio, so a portfolio that is 100% or even 50% in gold is a speculation strategy and not an investment strategy. 

If you agree with my rationale, you should think that the same applies to stocks and bonds. You may own stocks in different companies, sectors, and countries, but, all in all, you’re still tied to the health of the global stock markets. In a large cyclical correction, like the one we saw in 2008, all your paper assets will behave the same, and if you have invested 100% of your portfolio in Wall Street’s products, you may suffer heavy losses. 

So, anyone who has their entire portfolio in stocks and bonds is, in my opinion, a paper asset speculator. Most likely, they just wanted a way to save for their retirement and never intended to be a speculator of any kind, but Wall Street got them there.

The percentage allocated to each asset class in a portfolio is up for debate. We, at Gold Alliance, recommend up to 30% in gold and silver, leaning on historical events where an optimal allocation would have balanced out the negative effects of any financial crisis that occured in the past. Ray Dalio, objectively the most successful financial investor of all times, publicly recommended 5–10% in gold in 2019, but fast-forward to 2021 and in the different world we live in, his hedge fund, Bridgewater Associates, held 20% in gold although it has investment opportunities all of us can only dream of.

I’m mentioning these different percentages to show you that there is a valid and healthy argument on the merits of investing a higher or lower percentage in gold, stocks, bonds, or real estate, but I have never heard a good argument for 0% in gold as both history and economics show the opposite (riffing on Dalio’s famous quote). 

However, 0% in physical gold is the standard for the over 100,000 people we speak with every year, which reflects the picture out there. Why do so few people own any amount of gold? The reason is simple: Wall Street doesn’t sell physical gold (we’ll get to gold ETFs in another article). The pushback to gold appears in the financial media, the paid and published research on behalf of Wall Street firms, and the training they provide or, rather, don’t provide to financial advisors, aka Wall Street brokers. 

So, how come we have avoided gold, doing the exact opposite of what all your ancestors did for over 5,000 years? It starts with how Wall Street interprets diversification. 

Diversification or “till death do us part”

Diversification is one of the key principles for achieving better performance from our investments. The logic behind diversification is basic: Don’t put all your eggs in one basket, so reduce risk by allocating investments across various financial instruments. Harry Markowitz, a Nobel Prize–winning economist, has established the math behind what is now called Modern Portfolio Theory, which proved diversification works. Period. It also proved that diversification is extremely effective when the assets in your portfolio are not correlated to each other, meaning they don’t move in tandem.

While all this makes logical sense, most of us have a hard time adhering to it. We want to win with our entire portfolio, and we don’t understand why we need to sacrifice our total amount invested to be placed in assets we don’t necessarily believe in or understand just because they are uncorrelated to assets we believe in. 

We also have a natural bias towards non-diversification since we are not diversified in major areas of our lives. We put all our eggs in one basket when it relates to our jobs and our spouses. And when we are not happy with them to the point of losing hope that things will get better, we don’t diversify by reducing time spent at an unrewarding job or with a bad spouse and adding another job or a second spouse. We will usually cut our losses and move all our eggs into a new basket. 

These are the two main undertones that govern our behavior when it relates to the concept of diversification: the logical side (you need to be diversified because it’s proven to work, which we understand) and the emotional side (when things are good or bad, don’t diversify — “for better, for worse… till death do us part“).

Wall Street’s take on diversification into gold

Wall Street promotes the importance of diversification. They’ll tell you that you must diversify into assets that are uncorrelated, and they will set you up in a “balanced” and “diversified” portfolio. But while a good portfolio setup by a major brokerage firm will have uncorrelated assets, portfolio success is achieved with the most-uncorrelated assets. What Wall Street is doing is diversifying your financial paper assets (stocks and bonds) with other types of stocks and bonds and not with gold, one of most, if not the most, uncorrelated assets to stocks and bonds. 

Why is gold so uncorrelated to stocks? Think about it: Physical gold is a debt- and obligation-free asset. Once you own physical gold, it is also completely free of third-party risk. We are comparing a risk-free asset like gold to stocks or bonds of a corporation, which carry market risk, management risk, competition risk, technological disruption, etc. So, if you have stocks in your portfolio, not having gold in your portfolio is the same as not having the most optimized portfolio. This is one of the more challenging aspects for investors. Owning a portion of gold will improve your overall stock and bond market portfolio, especially because of the cyclical market crashes.

As seen in the chart below, gold provided effective protection against market stress by returning an average of 6.4%, whereas stocks lost 21.7% on average. That’s what true diversification gets you.

This is why the most sophisticated hedge funds in the world, like Ray Dalio’s firm, which have their pick of Harvard and Stanford analysts, diversify their cutting-edge trading activities — which include stocks, bonds, derivatives, and options — with, yes, good old gold. This is also why central banks fortify their balance sheets with timeless gold. 

Warren Buffett once said that “diversification is protection against ignorance.” Some see this as a way of the world’s most savvy investor to say that if you are not ignorant towards specific assets, industries, or asset classes, you don’t need to diversify. I take the word “ignorance” as more broadly meaning our inability to know what will happen tomorrow, how markets will behave, and even how competent are the people who pick the investment assets for our portfolio, so diversification protects us from all these different types of ignorance. And when you diversify a stock market portfolio, you need to do it with the assets that are the most uncorrelated to the main assets in your portfolio. The easy choice — the one with a 5,000-year track record — is gold.