Remember the last time the share market took a nosedive? Your stomach might have done the same. It's moments like these that remind us why defensive assets are popular. Gold and bonds can be used by investors as a way to hedge their investments. In theory, they're designed to soften blows when markets get rough.

But how do these two stack up against each other? Let’s answer that question, and explore how gold and bonds compare as long-term investments. We’ll look at their key features, benefits, risks and how they behave in different market conditions. It’s information that can help you make informed decisions about investing your hard-earned money.

Whether you're new to investing or looking to diversify, understanding the differences between gold and bonds can guide your investment strategy. Let's jump in and see how these two defensive assets stack up against each other.

What are defensive assets?

Defensive assets are investments that aim to protect your wealth during market downturns. They typically don't swing as wildly in value, and they can potentially provide stability to your portfolio.

Think of defensive assets as the steady performers in your investment mix. They're not usually the stars, but they seek to be reliable supporting actors. Their main job is to help balance out the risks from growth assets like shares.

Common features of defensive assets include:

• Lower volatility than growth assets
• Potential to generate income
• Generally lower returns over the long term
• Tendency to hold value (or sometimes even increase) during market stress

Investors can use defensive assets to:

• Preserve capital
• Reduce overall portfolio risk
• Provide a source of funds for rebalancing
• Generate income

It's worth noting that no asset is completely risk-free. Even defensive assets can lose value in certain conditions. The key is understanding how they work and how they fit into your broader investment strategy.

Defensive assets can play a crucial role in a diversified portfolio . Their purpose is to help smooth out your investment journey, potentially making it easier to stick to your long-term plan when markets get bumpy.

In the following sections, we'll take a closer look at two popular defensive assets: gold and bonds. We'll explore their unique characteristics and how they might behave in different market scenarios.

Gold as a defensive asset

Gold has been valued for thousands of years. It's often seen as a safe haven during times of economic uncertainty.

Throughout history, gold has generally maintained its value. It's been used as currency and a store of wealth across many cultures. This long track record contributes to its appeal as a defensive asset.

Gold often moves differently to other assets like shares and bonds. When share markets fall, gold prices may rise as investors seek safety. This can help offset losses in other parts of your portfolio.

What are the pros and cons of investing in gold?

Gold has been a sought-after investment for centuries. Like any investment, it comes with its own set of advantages and drawbacks. Let's weigh up the potential pros and cons of investing in gold:

Potential pros:

• Hedge against inflation: Gold often maintains its purchasing power over time, protecting wealth from the eroding effects of inflation.
• Portfolio diversification: Gold typically moves independently of stocks and bonds, helping to spread risk in a portfolio.
• Performs well during economic uncertainty: In times of economic or political turmoil, gold often acts as a safe haven, potentially increasing in value.
• Tangible asset: As a physical commodity, gold offers the security of owning something real and touchable.
• Liquid and easily tradeable: Gold can be quickly bought or sold in various forms, from physical bullion to ETFs, providing flexibility for investors.
• No counterparty risk: Gold's value doesn't depend on a company's or government's ability to fulfil financial obligations.

Potential cons:

• Non-income producing: Unlike stocks or bonds, gold doesn't pay dividends or interest, limiting potential returns to price appreciation only.
• Can be volatile in the short term: Gold prices can fluctuate significantly over short periods, which may be unsettling for some investors.
• Storage and insurance costs for physical gold: Owning physical gold comes with the added expenses of secure storage and insurance.
• Subject to price speculation: Gold prices can be influenced by investor sentiment and speculation, sometimes disconnecting from fundamental factors.
• May underperform other assets in bull markets: During strong economic growth periods, gold may not keep pace with the returns of stocks or other growth assets.
• Can be affected by currency fluctuations: As gold is typically priced in US dollars, changes in currency exchange rates can impact its value for investors in other countries.

How can I invest in gold?

There are a few ways you can invest in gold :

1. Physical gold. You can buy gold coins or bars to hold as a tangible asset.
2. Gold exchange-traded funds (ETFs). Gold ETFs track the price of gold without owning the physical metal.
3. Gold mining shares. Purchase shares in gold mining companies to benefit from any profits or gold price movements.

Physical gold offers direct ownership but comes with storage concerns. Gold ETFs provide easier trading and storage. Mining shares offer exposure to gold prices but come with company-specific risks. For more details on how you can invest in gold, read our article ‘Should I invest in gold?’ .

It's important to remember that while gold can offer protection, its price can also fall. It carries risks (as with any investment) and may not be suitable for every investor.

Understanding gold's unique properties can help you decide if it fits your investment strategy. Next, we'll explore bonds as another defensive asset option.

Bonds as a defensive asset

Bonds are loans made to governments or companies. They're usually known for providing steady income and relative stability.

As we just hinted, there are generally two main types of bonds – government and corporate. Government bonds are backed by the government, which can potentially make them less risky. Corporate bonds are issued by companies and offer higher returns but come with possibly more risk.

When you buy a bond, you lend money to a government or company. In return, you receive interest payments over time. At the end of the bond's term, you get back your principal amount and possibly some interest. This predictability can potentially help balance more volatile investments in a portfolio.

What are the pros and cons of investing in bonds?

Investing in bonds can be an effective way to add stability to your portfolio. Understanding the potential pros and cons can help you decide if bonds align with your investment goals.

Potential pros:

• Regular income stream: Bonds typically provide periodic interest payments, potentially offering a steady cash flow for investors.
• Generally lower risk than shares: Bonds usually have less price volatility than shares, possibly making them a more stable investment option.
• Potential for capital gains: Bond prices can increase if interest rates fall, offering the possibility of selling at a profit before maturity.
• Portfolio diversification: Bonds often move differently to shares, helping to spread risk in a diversified investment portfolio.
• Government bonds can offer high security: Bonds issued by stable governments are considered very low-risk investments.
• Predictable returns: With fixed interest payments and a set maturity date, bonds can potentially offer more predictable returns than many other investments.

Potential cons:

• Interest rate risk: When interest rates rise, existing bond prices typically fall, potentially leading to capital losses if sold before maturity.
• Inflation risk: Fixed bond payments may lose purchasing power over time if inflation rates are high.
• Lower long-term returns compared to shares: Historically, bonds have provided lower returns than shares over extended periods.
• Credit risk for corporate bonds: There's a risk that companies issuing bonds might default on their payments.
• May underperform during economic booms: In times of strong economic growth, bonds may not keep pace with the returns of growth assets like shares.
• Less liquidity for some bond types: Certain bonds, especially those not frequently traded, can be harder to buy or sell quickly without affecting their price.

Understanding these pros and cons can help you assess whether bonds align with your objectives and risk tolerance.

How can I invest in bonds?

Here are the various ways you can invest in bonds:

1. Direct purchase from the issuer. This includes government bonds and corporate bonds. You typically purchase these through a broker or financial institution.
2. Bond funds that pool money from many investors to buy a diversified portfolio of bonds. These funds can be managed actively or passively. They offer diversification and professional management.
3. Bond ETFs trade on stock exchanges like shares. They track the performance of a specific bond index. Bond ETFs offer liquidity and ease of trading.
4. Bond dealers. Specialised bond dealers buy and sell bonds. They can provide access to a wide range of bonds, including those not available on public exchanges.
5. Online platforms (like Pearler ) that allow you to buy and sell bonds directly. These platforms provide a convenient way to invest in bonds with lower fees.

Exploring the different methods for bond investing can help you find the right approach to fit your investment strategy.

What are the key differences between gold and bonds?

Though gold and bonds are both considered defensive assets, they have distinct characteristics. Understanding how they compare can help you decide which one suits your investment needs.

Let's compare them across several key features:

Aspect	Gold	Bonds
Performance during crises	Often rises during economic downturns	Government bonds typically provide steady returns
Volatility	Can be highly volatile short-term	Usually less volatile than shares
Income generation	No regular income	Generally regular interest payments
Liquidity	Highly liquid (physical gold and ETFs)	Generally liquid (varies by bond type)
Inflation protection	Can be an effective hedge against inflation	Limited, especially for fixed-rate bonds. May lose value in high inflation.
Long-term growth	Depends on market conditions, no income	Predictable returns, stability, and income
Counterparty risk	No counterparty risk	Varies by issuer
Currency risk	Typically priced in USD	Available in various currencies
Potential returns	Depends on price appreciation	Interest plus possible capital gains

Comparing these aspects can help you understand the roles of gold and bonds in a defensive investment strategy. Each has unique benefits and risks. The choice between gold and bonds, or a combination of both, depends on your circumstances and preferences.

But deciding between the two is easier said than done. How can you figure out whether either, both or none is right for you and your long-term investing goals? We’ll explore that next.

Gold vs bonds: which one should I choose?

Choosing between gold and bonds isn't a one-size-fits-all decision. Your choice depends on your unique financial situation and goals. Here are some factors to consider:

Investment objectives

Are you looking for steady income or capital preservation? Bonds can offer regular interest payments. Gold relies on price appreciation for returns.

Risk tolerance

How comfortable are you with price fluctuations? Gold can be more volatile than many bonds, especially government bonds.

Time horizon

Are you investing for the short-term or long-term ? Bonds have set maturity dates. Gold can be held indefinitely.

Income needs

If you need regular income, bonds could be more suitable given their predictable interest payments. Gold doesn't provide periodic payments.

Liquidity requirements

Both gold and bonds can be liquid, but the ease of buying and selling can vary. Consider how quickly you might need to access your money.

Current portfolio composition

Consider how gold or bonds would fit with your existing investments. Both can offer diversification benefits.

Gold and bonds serve different purposes in an investment portfolio. Keep in mind that a balanced portfolio may include a mix of gold and bonds for stability and growth potential. The right mix (or no mix at all) depends on your investment strategy and the factors listed above.

Gold vs bonds – finding the right balance

Gold and bonds are both popular defensive assets. Each offers unique benefits and risks. Gold can potentially hedge against inflation and provide stability during economic downturns. Bonds can offer regular income and lower volatility.

Remember, investing in gold, bonds, both, or neither are all valid choices depending on your circumstances. It's not about picking a winner, but finding what works best for your financial plan. And if you're in doubt, consider seeking advice from a licensed financial adviser. They can help you understand how these investments might fit into your overall strategy.

Keep learning and stay informed to make the best choices for your financial future.