Gold has an image problem among young investors. It is often associated with doomsayers, gold bugs, and pessimists who expect the collapse of the financial system, which makes it unappealing to optimistic young investors who are focused on growth and compounding. But this characterization misunderstands the role that gold and other precious metals can play in a portfolio, even one focused on long-term growth. A small allocation to gold provides diversification and a hedge against the specific risks that stocks and bonds do not hedge — currency debasement, high inflation, and systemic crisis — which can improve a portfolio’s risk-adjusted returns over full market cycles. For young investors who are building portfolios they will hold for decades, understanding the role of precious metals is a valuable part of constructing a resilient, all-weather portfolio that can weather whatever the future brings.
Why Gold Belongs in a Growth Portfolio
The case for a small gold allocation in a growth portfolio is not based on the expectation that gold will outperform stocks. Over long periods, stocks have historically outperformed gold, and a young investor whose portfolio is mostly stocks will likely see higher returns than one who holds a significant gold allocation. The case for gold is based on diversification, because gold’s returns have historically had a low correlation with stock returns, which means that gold often performs well during the exact periods when stocks perform poorly. This diversification benefit reduces the overall volatility of the portfolio and, more importantly, reduces the depth of drawdowns during stock market crashes, which helps investors stay the course rather than selling at the bottom.
The diversification benefit is most valuable during the specific periods when it is most needed. During the 2008 financial crisis, when stocks fell roughly 50%, gold rose. During the 2020 pandemic crash, when stocks fell sharply, gold initially declined but recovered quickly and reached new highs as central banks cut rates. During periods of high inflation, such as the 1970s, gold soared while stocks struggled. These are the periods when a gold allocation earns its place, by providing returns when the rest of the portfolio is under pressure. The investors who hold a small gold allocation through calm periods, when it may seem like dead weight, are the investors who benefit from it during turbulent periods, when it matters most.
The Inflation Hedge
One of the most important roles of gold in a portfolio is as an inflation hedge. Gold is priced in dollars, and its value, unlike the value of paper currencies, cannot be diluted by money creation. When central banks expand the money supply, the purchasing power of each dollar falls, but the dollar price of gold tends to rise, because more dollars are required to buy the same amount of gold. This makes gold a natural hedge against the debasement of fiat currencies, which is one of the specific risks that stocks and bonds do not reliably hedge.
For young investors, who will hold their portfolios for decades, the cumulative effect of inflation is enormous. Even at a modest 3% annual inflation rate, the purchasing power of a dollar falls by roughly half over 23 years. At 4%, it falls by half over 18 years. Gold, as a real asset, maintains its purchasing power over long periods, which means a gold allocation helps preserve the real value of the portfolio through inflationary cycles. While stocks also provide some inflation protection, because companies can raise prices, the protection is imperfect and lagged. Gold provides more direct and immediate inflation protection, which makes it a valuable complement to a stock portfolio for investors concerned about the long-term erosion of purchasing power.
The Real Interest Rate Driver
The most important driver of gold’s price over the modern era is the real interest rate, which is the nominal interest rate minus inflation. Gold pays no yield, which means its opportunity cost is the real return that could be earned on bonds and cash. When real interest rates are positive and rising, gold faces a headwind, because investors can earn a real return on bonds without taking price risk. When real interest rates are negative or falling, gold faces a tailwind, because the opportunity cost of holding a non-yielding asset falls. This relationship explains much of gold’s longer-term price action, and it is one of the most important fundamentals for gold investors to understand.
For young investors, the real interest rate is a key input for deciding when to add to a gold allocation. During periods of negative real rates, when gold has a tailwind, adding to a gold allocation is historically well-timed. During periods of high positive real rates, when gold faces a headwind, it may be better to delay additions or to maintain the existing allocation without adding. This does not mean timing the gold market, which is difficult, but it does mean being aware of the interest rate environment and adjusting the pace of gold accumulation accordingly. The investors who understand the real rate relationship make more informed decisions about their gold allocation and avoid buying aggressively during periods when the fundamentals are unfavorable.
Silver and the Industrial Precious Metals
Beyond gold, other precious metals can play a role in a diversified portfolio, though they are more speculative and more volatile. Silver, as discussed elsewhere, has a dual character as both a monetary and an industrial asset, and its price is influenced by industrial demand, particularly from the solar energy industry. For young investors who want exposure to the precious metals complex with an industrial growth component, silver can be a complement to gold, providing exposure to the energy transition and to industrial demand growth. However, silver’s greater volatility means it should be a smaller position than gold for most investors.
Platinum and palladium, which are primarily industrial metals used in automotive catalytic converters, are more specialized and more speculative. Their prices are driven by automotive production cycles, emission regulations, and supply dynamics in a small number of producing countries. For most young investors, these metals are too specialized and too volatile to warrant a significant allocation, and they are best left to more sophisticated investors who understand their specific supply-demand dynamics. The core precious metals holding for most young investors is gold, with silver as an optional complement for those who want additional exposure to the complex.
How to Hold Gold
For young investors, the most practical way to hold gold is through a gold-backed exchange-traded fund, which holds physical gold and issues shares that trade on a stock exchange. These funds provide the convenience of stock trading with the backing of physical metal, and they have low costs and high liquidity. The investor buys shares of the gold ETF through their brokerage account, just as they would buy a stock, and the shares represent a claim on the physical gold held by the fund. This approach avoids the costs and complications of buying, storing, and insuring physical gold, which can be expensive and cumbersome.
Some investors prefer to hold physical gold, in the form of coins or bars, for the security of having a tangible asset outside the financial system. This approach has its merits, particularly for investors concerned about systemic risk, but it involves costs for storage and insurance that can be significant, and it is less liquid than an ETF. For most young investors, the convenience and low cost of a gold ETF make it the preferred vehicle, though a small holding of physical gold can provide additional peace of mind for those who value it. The specific vehicle matters less than the allocation itself, because the diversification benefit comes from holding gold, regardless of the form.
Sizing the Allocation
The appropriate gold allocation for a young investor is modest, typically between 5% and 10% of the total portfolio. This allocation is large enough to provide meaningful diversification during periods when it is needed, but small enough that it does not significantly drag on returns during periods when stocks are performing well. The allocation should be held permanently through market cycles, rather than traded based on market conditions, because the diversification benefit is most realized during the specific periods when investors are most tempted to sell — the periods when other assets are under the most pressure.
The most important discipline for young gold investors is to hold the allocation through calm periods, when it may seem unproductive, and to rebalance back to the target allocation periodically. When stocks rise and gold lags, the gold allocation shrinks, and rebalancing involves selling some stocks to buy gold, which restores the target allocation. When stocks fall and gold rises, the gold allocation grows, and rebalancing involves selling some gold to buy stocks at depressed prices. This rebalancing discipline improves returns over time, because it forces the investor to buy low and sell high, and it maintains the diversification benefit of the gold allocation through changing market conditions. For the young investors who include a modest gold allocation and who manage it with discipline, precious metals provide a valuable hedge that improves the resilience of the portfolio without sacrificing long-term growth.