All that Glitters … Doesn’t

I’ll be blunt.  Many people think gold is a great investment, but it is not the best way to hedge yourself against inflation. You might make money in gold, even a lot.  You might lose money in gold. Either way, it isn’t a smart move if your objective is to protect your money against inflation.

The gold theory

Many financial “experts” are constantly trying to tie gold’s performance to inflation. The argument generally goes that fiat money can be devalued, but the supply of gold is limited, so its value should hold better.

I agree that gold can be a decent hedge against inflation, in the long, long term.  Like the 300 year long frame. I don’t know about you, but if I’m investing for 300 years I’m not going to be satisfied shooting for returns that just tread water and meet inflation. I’m going to shoot for returns that beat inflation – meaning I still wouldn’t own gold.

Gold offers poor protection

There is a saying that an ounce of gold could buy you a good men’s suit (or toga) in ancient Rome, and it can basically do the same today.  This seems to hold true, somewhat. Gold is now $1,370 per ounce. Does that buy a good men’s suit?  I think part of the reason this saying seems to hold truth is because of the ambiguity associated with what is a “good” men’s suit. Is it $300 or $20,000 There is quite a lot of wiggle room there.

But if you are dealing with a time frame of 10 years – or even 50 years – gold just won’t do as inflation protection. It is too volatile. There are much better ways to hedge inflation that have been well known for decades.

A better way to keep pace with inflation

In 1983, Dimensional Fund Advisors started the One-Year Fixed Income fund, specifically to allow investors to keep pace with inflation. It has done the job just as it should. Below is a chart of the fund (in blue) and inflation (in green) since August 1983. You can see how the fund has provided a stable, low volatility way to meet or beat inflation. Keep in mind that this graph is covering a lot of time.  For nearly 30 years this strategy has done exactly what it is supposed to do.


What about gold?  Think about how wild its ride has been through the 1980s, 1990s and 2000s. It has been both horrible and wonderful.

Here is a chart of gold for a 20 year period of time from August 1983 to July 2003. Twenty years…..and gold is down!! So there is a 20 year period of time when it certainly didn’t do a good job of hedging inflation.

Gold 80-2003

Here is the good period for gold – the last ten years – where it did far, far better than inflation. But is this what you want just to hedge inflation? Something that can be down after 20 years and then explodes upwards over the next 10? You can get less volatility in the stock market.

gold 2003 - today

Vegas, baby!

In order to get a simple inflation hedge, you just don’t need anything this risky. Unfortunately, a portfolio of one year high grade bonds is not at all exciting.  If you want excitement, go to Vegas. If you want good investment results, follow sound investment theory.

Photo by Mark Herpel