How Gold helps your portfolio?

Asset allocation is a key principle in investing, and gold has been considered as a crucial asset class for diversification for a long time. Gold has historically exhibited a low correlation to stocks, meaning it can provide a hedge against market volatility.

But a question that often arises is, how much gold should you actually add to your portfolio? Let’s explore the importance of having gold in your  portfolio and how various scenarios of asset allocation would have played out.

For this analysis, data from 1st October 2009 till 16th October 2024 has been considered for Nifty 50 TRI as an equity benchmark and  MCX Gold Spot price as the benchmark for gold. The portfolio has been rebalanced on a yearly basis. A 15 year time period has been considered for a long term analysis. Let's get into it.

Scenario 1: All Equity

Let's look at the base case scenario and see what would have happened if an investor had invested ₹1 Lakh in the Nifty 50 TRI Index in Oct 2009.

The investor would be sitting at a portfolio of about ₹5.88 Lakhs, which is a compounded annual growth rate (CAGR) of ~12.50%. However, the investor would also have experienced a maximum drawdown of -38%.

Maximum drawdown shows the largest fall your portfolio has experienced from its highest point to its lowest point, helping you gauge how resilient your portfolio is to downturns.

In this scenario, it would have been a fall from the investment value of ₹2.75L to ₹1.69L during the covid market crash that happened from January 2020 to March of that year. Let's see if adding gold changes anything.

Scenario 2 : With Equity and Gold

For the same time period had the investor invested ₹1L rupees, but with an asset allocation of  Nifty 50 TRI and Gold (rebalanced annually), here is how it would have looked:

For a 90:10 allocation into equity and gold, the investment would have grown to ₹5.76L, with a CAGR of 12.35% which is a 0.15% drop from scenario 1 and a maximum drawdown of -34.1%.

An 80:20 allocation would yield ₹5.86L, a 12.48% CAGR, with the maximum drawdown dropping further to -30.01%.

With a 70:30 ratio,  ₹1L would have turned into ₹5.91L, a CAGR of 12.54%, and the maximum drawdown further reduces to about -26%. To visualize this drawdown in terms of your portfolio value, the COVID market fall from January to March 2020  in your portfolio value would have been from ₹2.82L to ₹2.09L.

The overall picture

Historical data indicates that having Gold in a portfolio can significantly reduce the drawdown of your overall portfolio, by reducing volatility, especially during market downturns. 

Here, risk-adjusted return measures how much return an investment generates for the risk taken.

The chart demonstrates that adding Gold to a portfolio can reduce the maximum drawdown across various asset allocations, with minimal impact on overall returns.

Conclusion

In conclusion, having gold in your portfolio has historically shown potential benefits, particularly in reducing volatility and limiting drawdowns during market downturns. Gold's low correlation with equities may make it an effective diversification tool. While the exact amount of gold you should hold depends on your individual risk tolerance and financial goals, past data suggests that even a small allocation can improve a portfolio's resilience. It's advisable to consult a financial advisor who can help determine the right allocation based on your specific needs and circumstances.

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Please note that this article or document has been prepared on the basis of internal data/ publicly available information and other sources believed to be reliable. The information contained in this article or document is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party in any manner. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article or document.

Past performance may or may not sustain in future and should not be used as a basis for comparison with other investments. The AMC, Mutual Fund and its affiliates make no guarantees, promises, or forecasts regarding any type of return.

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Published on Oct 28th 2024