Thursday, September 8, 2011

Gold As An Investment

This article is inspired by some of the posts I've seen lately around the blogosphere on the benefits and drawbacks of investing in gold. I've never really made my feelings on the shiny metal known on this blog before, so I thought I'd put it down in writing today. First off, I'm not a gold bug or a doomsayer. I'd like to consider myself a pretty level-headed guy, and in such I can see the pros and cons to owning gold. I don't necessarily think it's all-or-nothing. You can own many types of investments, and gold can be a part of your portfolio. That being said gold is very expensive at current prices, and price notwithstanding I dislike owning it for a number of different reasons. My thoughts on gold (and silver to a lesser degree) are as follows:

Why I like dividend growth stocks:

First, let's discuss my motivation for owning dividend growth stocks (which comprise 100% of my portfolio as of today). I'm looking to retire young, hopefully before 40 years old. I define retirement by being financially independent and in a position where passive income meets/exceeds expenses. Dividend stocks pay me to own them. I can invest in a high-quality company like Johnson & Johnson by owning their common stock. In turn, Johnson & Johnson pays me a dividend, quarterly. I can use that dividend to pay expenses, or I can reinvest it. Because I can use those dividends to pay expenses, this investment is a viable approach to retiring young and achieving financial independence (from paid employment).

I look at dividend stocks like this: my portfolio is a fruit tree. My individual positions are branches on that fruit tree. From those branches hang fruit, which are the dividends. I pick the fruit quarterly, as that is the frequency most companies pay dividends. Every quarter I pick the fruit, and the next quarter new fruit grows. This process repeats itself many, many times (hopefully). If I were to sell the stocks by cutting the branches, I would no longer be able to pick that fruit (and pay my bills). That would be an undesirable situation, for many reasons. As long as the fruit grows and I pick it, my bills can be paid.

Why I don't like gold:

Gold does not pay me dividends. In fact, not only does it not pay me to invest in it...but quite the opposite it requires me to pay out additional costs in the form of safe deposit boxes or other storage means in which to keep it safe. This, of course, is only true for the physical form of gold which is the only type I would own. Owning stock in mining companies or GLD doesn't provide the tangible ownership of gold. Paper gold, like GLD, is simply tied to the market's view on the value of gold. You could own GLD for the short-term fluctuations in the price of gold as a commodity, but I think if you are looking for a true long-term store of wealth the physical metal is the way to go.

Gold is one of the only investments, besides true cash, that doesn't provide any type of cash flow. Stocks, bonds, real estate, CD's and even bank accounts provide cash flow in return of an investment. Gold just sits there, and continues to shine. I can see the allure of gold, as holding it in your hand provides some type of mythical elation that has made it popular for thousands of years. But allure doesn't pay my bills. Cash flow does. The only way you can receive cash for gold is when you sell it. Back to my fruit tree example, that is the least desirable option: selling your assets for cash. This would, in my opinion, be akin to buying an empty house as in inflation hedge/investment and then, instead of renting it for positive cash flow, storing it for years and eventually selling it because you need to raise cash. In addition to paying for the house, paying taxes/maintenance fees, and paying a premium to purchase it in the form of brokerage fees, you also paid taxes and fees to sell it. With gold, you pay a premium above spot to buy gold, pay maintenance fees to keep it (safe deposit box), and then pay taxes and additional fees to sell it. During your time of owning gold you received no cash flow. With dividend stocks I received my quarterly fruit, with which I can pay my bills. With real estate you can rent it out. You can't rent out gold. 3 oz. of gold in a safe deposit box doesn't pay my bills, but dividends do.

Another point that is rarely discussed: high-quality companies like Johnson & Johnson produce products that people need. It is because of this that they can continue to raise prices with inflation. This is, in itself, a hedge against inflation. With those rising prices come rising earnings and, in turn, rising dividends. These dividends usually outpace inflation by quite a few points. Gold doesn't earn any money. It doesn't produce anything. Its value is dictated completely by what people are willing to pay for it.

Why I would consider owning gold:

I would consider gold as a very small portion of my portfolio, generally much less than 5%. Once my portfolio crosses the $100k mark I wouldn't mind owning 1-2 oz. of gold and increasing it by 1-2 oz. with every $100k. I would only own the physical metal, not stock. I want it in my hand, not a promise. The main reason, in my mind, for owning it would be as a hedge against some type of economic breakdown. For instance, the dollar collapses or the world economy has some type of major reset. Gold in this type of scenario could be invaluable as a bartering tool. Gold is a store of value: why this is I cannot explain. It's along the same lines as 4-letter words being "bad". Society sets its rules, and therefore it is what it is. Gold has value, and this will probably never change. You can use this to your advantage and have a small portion set aside just in case. I'm an eternal optimist, so I think the odds of actually needing physical precious metals highly unlikely. It is because of this, I'll likely only own a very small portion of it, if any at all.

The opinions above are just my 2 cents (or 1/1000000 oz.).

What about you? Do you invest in gold?

Thanks for reading.


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