By Odysseas Papadimitriou : CEO of the personal finance social network WalletHub
Between the near-collapse of the global financial system in 2008, concerns about the strength of the dollar, and the popularity of shows like “Doomsday Preppers” and “Storage Wars,” it’s really no surprise that many investors are considering the efficacy of buying commodities like gold and silver or even collectibles ranging from limited-edition stamps to vintage cars.
But, at the end of the day, are such investments actually wise or are there more strategic ways to allocate our cash in the current economic environment?
For most people, the answer to that golden question will be to eschew, or significantly limit, commodities plays given their modest historical returns and the expertise required to identify undervalued assets as well as ultimately offload them for a profit.
“Precious metals make sense only when an inflationary environment is expected, which would result in degradation of the dollar's value,” Dr. Vijay Singal, the J. Gray Ferguson Professor of Finance in Virginia Tech’s Pamplin College of Business, told CardHub in a recent interview. “Historically, precious metals have generated a real return of about 1-2%. Since that real return is not riskless, it is better to invest in equities which are also risky but give a much higher return.”
But investing decisions are hardly ever cut and dried, and this one is no different. The value of commodities investing really depends on your future outlook, current wealth, and the particular type of asset you’re interested in. So, with that said, let’s dive into the details.
Gold & Silver: Crisis Insurance
“Gold and silver are not investments per se for the average person,” says Mark Waldman, executive in residence for the Department of Finance & Real Estate at American University and co-owner of the investment advisory firm Waldman Financial Advisors. “They’re insurance, chaos insurance.”
In other words, gold isn’t meant to be a means of saving for retirement or a way to supplement your income, but rather is a hedge against the dramatic inflation of traditional currency in the event of a global economic meltdown. Most of us don’t have the luxury of preparing for such a dramatic worst-case scenario. We’re having a hard enough time as it is just staying out of debt – the average household currently owes roughly $6,600 to credit card companies – let alone building emergency funds to cover unexpected expenses or float us during periods of joblessness.
Nevertheless, if you do ultimately decide to add precious metals to your portfolio, the best course of action is to invest in tangible assets rather than funds based on options or futures contracts. “I’m not a fan of gold ETFs because mostly, but not entirely, they depend on paper gold,” Waldman says. “That part of the market is very heavily manipulated, and if there was ever a crisis, there’s just not enough gold so that all the people who own that stuff can get their gold.”
And while most people will gravitate toward gold in particular due to its perceived superiority over silver – you aren’t handed a silver medal when you come in first place at the Olympics, after all – many experts believe that silver is actually the better investment because of its lower price and higher growth potential.
Jewelry: Don’t Rationalize This Inefficient Investment
We’ve all met people who rationalize lavish purchases by saying that the product in question retains value well and can serve as an investment if need be. That contention could ultimately prove true, but aside from the fact that it’s important to buy things with a clearly defined objective in mind, you need to consider what returns you can realistically expect in the event you decide to sell.
There are a few factors conspiring against jewelry providing a worthwhile return on investment. For starters, it’s typically sold at a significant mark-up, which means acquisition costs will naturally depress profit margins. In addition, the materials used to make it aren’t usually pure and will therefore have less by-weight resale value than you might expect. Finally, most consumers don’t have the requisite expertise to, first of all, spot bargain buys and then ultimately broker an attractive sale price.
"I'm not personally a fan of jewelry as an investment because I am not an expert. The ability for me to buy and sell jewelry at fair prices is not something I have a great degree of confidence in,” says Dr. David S. Krause, director of the Applied Investment Management Program at Marquette University. “If someone wishes to hold gold, silver, diamonds, or some other valuable hard asset as an investment, I'd advise buying these as commodities rather than jewelry. If you like jewelry to wear or give to others, do it; but to think of it as an investment is more likely to be convenient rationalization."
Coins, Stamps & Other Collectibles: Not for Novices
Buying rare collector’s items – whether we’re talking about a limited-edition line of stamps or an automobile that is no longer in production – might seem like an easy way to score long-term appreciation-based profits. But, as is the case with jewelry, a certain level of expertise and disposable income is needed to make such an approach worthwhile.
“Very wealthy people have been shifting recently to physical assets. And we’re talking about collectible coins, collectible stamps, collectible cars,” Waldman says. However, “when wealthy people do it, they hire experts to get in the market for them, they buy quality. … If you are going to buy that stuff, you buy the best.”
Bottom Line: Diversification & Conservatism are Key
Ultimately, if precious metals and other commodities aren’t a great investment for the average person, it’s fair to wonder what is. The answer lies with the tried-and-true formula of using a well-diversified portfolio with minimal fixed costs to reduce risk and ensure steady returns over the long haul. While commodities can certainly play a role in such a portfolio, the centerpiece should be equity in dividend-dispensing blue chip companies that deal in consumer staples and have strong performance track records.
“Stocks, bonds, and some alternative assets (including real estate) are preferred. Not only do stocks and bonds trade in liquid markets, but the valuation is observable daily,” Krause says. “Precious metals have additional costs that stocks and bonds don't have: they have to be stored, transported, insured and appraised.”
All of this ultimately comes back to financial literacy. Those who internalize the lessons provided by the Great Recession regarding the importance of saving money, curtailing foolish spending, and not putting all of your proverbial eggs in the same basket will recognize the folly in going overboard with commodities investments. And those who attempt advanced investing techniques without the requisite time or expertise will simply be gambling with their future financial security.
So, take the time to become an expert or get out of the market. You don’t want to play the dangerous game of rationalizing non-investment spending as an investment in the name of temporary peace of mind.