We all want to protect the value of our hard-earned money and ensure our investments grow over time. But inflation can erode purchasing power and impact the value of investments. As someone committed to long-term investing, you might wonder how to safeguard your portfolio from the effects of rising prices. Known for its history as a safe haven, gold is often seen as a shield against rising prices. But is it the right fit for your investment strategy?

In this article, we’ll explore how inflation works and how gold and other assets interact with it. Understanding how gold behaves in inflationary periods can help you decide if it fits into your long-term plan. Let’s dive in and see where gold stands in the fight against inflation.

How does inflation work?

Inflation is something we all encounter, whether we realise it or not. It’s the gradual increase in prices over time, making the money you have today worth a little less tomorrow. For long-term investors, inflation is important to understand because it directly impacts the value of your investments and savings.

So, how does inflation work? Inflation happens when there’s more demand for goods and services than the supply can meet. This demand can push prices up. Sometimes, inflation is also driven by rising costs of production, like higher wages or more expensive raw materials. When costs go up, companies often pass those costs onto consumers, which also drives inflation.

You’ve probably noticed how a cup of coffee or a loaf of bread costs more now than five years ago. That’s inflation in action. While a little inflation is normal and even healthy for an economy, too much can make everything more expensive.

For investors, inflation can have a mixed impact. On one hand, certain investments, like shares in companies that can raise their prices, might keep pace with inflation. On the other hand, fixed-income investments, like bonds , may lose value as inflation rises. This is because their returns are generally fixed and don’t increase to match the higher prices.

Keep in mind that investment performance can vary significantly over time and in different market conditions. Past performance isn’t always indicative of future results, and all investments carry risks.

Benefits and drawbacks of gold as an investment

For many long-term investors, the appeal of gold lies in its history and perceived stability. But like any investment, gold comes with its pros and cons. Understanding these can help you decide if gold deserves a place in your portfolio.

Benefits

• Store of value : Over centuries, gold has maintained its worth, even when other assets have faltered. This makes it attractive during economic downturns when confidence in other investments might waver.
• Portfolio diversification : Gold also adds diversification to a portfolio. It tends not to move in the same direction as shares or bonds, which can potentially help balance out risk.
• Liquidity : Gold is a globally recognised asset, and you can convert it to cash relatively easily. Whether you hold physical gold or invest in gold-related financial products, you can usually sell quickly if you need access to your funds.

Drawbacks

• No income generation : Unlike shares or property, gold doesn’t generate income. You won’t receive dividends or rent from gold, so its value growth relies solely on price appreciation. This can make it less appealing if you’re looking for regular income from your investments.
• Price volatility : Gold can also be volatile. Its price can fluctuate significantly in the short term, driven by changes in investor sentiment, global events, or shifts in currency values. This volatility can be unsettling if you’re not prepared for it.
• Storage and security : If you own physical gold, safeguarding your investment can involve additional costs and responsibilities.

Gold can offer both benefits and challenges as part of a long-term investment strategy. Weighing up these factors can help you better understand how gold might fit into your overall plan to achieve your goals.

Gold in an inflated environment

Inflation can feel like a real hit to your savings. Prices go up, and suddenly your money doesn’t stretch as far. Naturally, you want to protect your investments from this. That’s where gold often comes into the conversation. But does it really hold up when inflation kicks in?

Gold has a reputation for being a solid hedge against inflation. When everything else gets more expensive, gold tends to keep its value or even go up. Why? Because it’s a physical asset, not tied to any currency. So when the dollar loses value, gold can stay steady or even shine a bit brighter.

But let’s not get too carried away. Gold doesn’t always perform well in every inflationary period. It depends on a range of factors, like how high the inflation is, what interest rates are doing, and what’s going on in the broader economy. For instance, if interest rates go up to fight inflation, gold might lose some of its appeal because other investments, like bonds, start looking better.

Generally, gold does well during high inflation, especially if there’s economic uncertainty. But that’s not a sure thing. Gold’s price can still bounce around, and there’s no guarantee it’ll always go up when inflation does.

Remember, investment results can vary, and what worked in the past might not work in the future. Inflation affects different assets in different ways. Before you decide to add gold to your portfolio as an inflation hedge, think about your financial goals and risk tolerance. It’s also a good idea to talk to a financial adviser to make sure any decisions you make fit with your overall strategy.

Gold vs other assets as an inflation hedge

Gold is proposed to protect against inflation, but how does it compare with other options like shares, bonds, real estate, super, and exchange-traded funds (ETFs)? Let’s take a quick look.

Gold vs. shares

Shares can be a solid choice during inflation, especially if you pick companies that can pass rising costs onto customers. These companies often keep pace with inflation, helping protect your investment’s value. But shares can be volatile, and in times of economic uncertainty, they might not perform as well. Gold, on the other hand, tends to shine when shares stumble, potentially offering a bit of balance to your portfolio.

Gold vs. bonds

Bonds are typically seen as safer, but they don’t always perform well during inflation. When prices rise, the fixed returns from bonds can lose buying power, making them less attractive. In contrast, gold isn’t tied to fixed returns, so it tends to hold its value better during inflation. But bonds provide regular income, while gold doesn’t, so it’s about what you need from your investments.

Gold vs. real estate and commodities

Real estate is perceived to be a good hedge against inflation because property values and rents in Australia have historically risen with inflation. However, real estate requires significant capital and comes with management responsibilities. Like gold, commodities such as oil or wheat also tend to rise with inflation. But commodities can be volatile, and investing in them often requires more specialised knowledge.

Gold vs. super

Superannuation (super) is a long-term investment vehicle that’s crucial for retirement planning. Super funds typically invest in a mix of assets, including shares, property, and sometimes even gold. While gold can help hedge against inflation within a super fund, it’s usually just one part of a diversified portfolio. Unlike gold, super offers tax advantages and employer contributions, making it a different kind of investment tool altogether. During inflation, the performance of your super will depend on its asset allocation and how those assets react to rising prices.

Gold vs. exchange-traded funds (ETFs)

ETFs are a popular choice for many investors due to their low cost and ease of access. They often track a basket of assets, which can include shares, bonds, or even gold. A gold ETF allows you to invest in gold without holding the physical metal. During inflation, the performance of an ETF depends on the underlying assets it tracks. A diversified ETF might offer more stability compared to holding gold alone, as it spreads risk across different asset classes. However, gold ETFs can be a straightforward way to get exposure to gold if you’re looking to hedge against inflation specifically.

No investment is foolproof. Gold, shares, bonds, real estate, commodities, super and ETFs all come with their risks and benefits. As we’ve said, past performance isn’t always a good predictor of future results. But by comparing these options, you can start to see where gold might fit in your portfolio – or where it might not.

Other factors to consider

When you’re thinking about adding gold to your portfolio, it’s important to consider the bigger picture. Gold can play a role in protecting your investments, but it’s not the only option. Here are a few things to keep in mind.

Watch economic indicators

Pay attention to key economic indicators like inflation rates, interest rates, and economic growth. These factors can influence how gold and other assets perform. Keep an eye on these to help you make more informed decisions about when and how much to invest in gold.

Balance gold with other investments

Diversification is key. Gold can add stability to your portfolio, but relying too much on any one asset can increase risk. Consider how gold fits with your other investments, like shares, bonds, and real estate. A diversified portfolio is generally more likely to weather different market conditions.

Think of the tax implications

In Australia, gold investments can have specific tax considerations, especially if you’re holding physical gold. Understanding how these might affect your overall returns is important. You might want to check with a tax professional to see how gold fits into your tax strategy.

Stay informed

The value of gold, like any investment, can change quickly based on global events, economic policies, and market sentiment. Staying informed about these factors can help you manage your investment more effectively.

Note: The information here is meant to help you think through your options, but it’s not a substitute for professional advice. Consider your financial situation and goals before making any decisions, and talk to a financial adviser if you’re unsure.

The goal is to build a portfolio that supports your financial future, whatever the market conditions.

Does gold have a place in your strategy?

Gold is one option among many to help protect your investments against inflation. but it’s not without its challenges. The key is to understand how gold fits into your broader strategy and whether it aligns with your goals.

Investing is about balance. It involves weighing the pros and cons, understanding the risks and making choices that suit you as an investor. Gold might play a role in your portfolio, but it’s important to look at the full picture.