The other day in reaction to our post on gold’s role in a diversified portfolio well known blogger and CNBC contributor, Josh Brown, engaged us in a discussion via Twitter when he asked;
If the world goes to hell, and I have 5% of my portfolio in $GLD, how exactly has that helped me?Our reply over two tweets;
My answer is gold as one of several holdings that tend to not look like equities, reducing extent to which the overall portfolio gets hit may not work the next time but did work before, been saying this many years.Where the context is whether or not to use portfolio diversifiers like gold, of course gold is not the only choice available, the issue becomes how advisors can effectively use portfolio diversifiers for their clients.
The big idea is that the stock market goes up more often than not but when it does go down it scares the hell out of clients. During these large declines some advisors will use tools like gold, hedge fund replicators, absolute return, market neutral, funds that sell short or any other products that tend to not look like the stock market to try to spare clients from the full effect of the decline.
The use of portfolio diversifiers is not a static allocation. If stocks go up most of the time then the need for diversifiers lessens during the bull phase of the cycle. During bear phases of the cycle the potential utility of more diversifiers in the portfolio increases. Used effectively, these types of diversifiers can serve to improve risk adjusted returns.