Build a diversified portfolio But, remember that stocks outperform in the long run

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The performance of gold during the last 2 years has been truly spectacular. Gold has not just been a safe haven in recent times of uncertainty and turbulence; it has also been a well performing asset class, beating many other asset classes. Gold’s steady climb to record highs has been attention-grabbing news, particularly in a gold-loving country like India. However, investors should have a clear perspective of the performance of various asset classes in the long run, while investing money.

It is important to have a well-diversified portfolio and gold should be an integral part of such a portfolio. But putting all eggs in the gold basket would be imprudent. Asset allocation should be done in accordance with one’s financial goals. For a young long-term investor, it is important to have a portfolio skewed in favour of the best performing long-term asset class.

Which is the best performing asset class in the long run?

Globally, with very few exceptions, equity has been, by far the best performing asset class for long periods: whether it is 30 years, 50 years or 100 years. In emerging markets like India, gold has given very good returns even when when global gold prices stagnated, thanks to currency depreciation. Even then, the best performing long-term asset class has been equity, not gold. The following table shows the returns from gold, Rs 1000 invested in FD and PPF in March 1980 till March 2020 and appreciation in Sensex over this period.

Returns from Gold, FD, PPF & Sensex during 1981-2020

Average inflation during this 40-year period has been 6.69%.

It is important to understand that different asset classes perform differently during different periods. For instance, gold gave negative returns during 1995-2000 when its price fell from 4680 to 4380 while it appreciated by more than 250 percent during 2005 to 2010.  Sensex appreciated in all the 5-year periods from 1980 to 2020, but its performance has been mediocre during 2000 to 2005 while it appreciated by more than 400 percent during 1990 to 1995 and by more than 250 percent during 2005 to 2010. So, it is the long-term performance that matters. And, when we consider the near 40- year performance, Sensex is the clear winner with average annual return of 14.08 percent followed by PPF, FD and Gold with 9.67 %, 8.85% and 8.7% returns respectively.

This lesson from financial history is important. So, investors should build a diversified portfolio with asset allocation in accordance with one’s financial goals. For young investors with a long time horizon, equity has to be the asset class with the maximum weightage.

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