Gold and bitcoin are weird.
Neither is especially useful in the here and now in any practical sense. Bitcoin’s promise as a deregulated digital currency remains just that—a promise. And nobody carries around gold in their hip pocket to purchase goods or services anymore.
While both are “mined,” their only real-world or virtual applications seem to be as tools of pure speculation—or as safe-haven assets. People flock to gold whenever the world goes half a bubble off plumb. More and more, they also seem to flock to bitcoin.
The price of an ounce of gold and a single bitcoin bounced dramatically after governments and central banks around the world, but especially in the United States, pumped money into consumers’ wallets and banks’ coffers as Covid-19 caused an unprecedented global recession.
Many investors are unsure what place if any, either asset has in their portfolio. Here’s what you need to know to understand how bitcoin and gold might fit into your investment strategy.
Gold Isn’t Much Of An Inflation Hedge
First, the bottom line: You can add gold to a well-diversified portfolio of stocks and bonds, but experts believe it shouldn’t amount to more than 10% of your holdings.
That said, it’s essential to know why you’re adding gold to your holdings. If it’s to fend off inflation, think again. While research shows the value of gold remains constant over a very, very long period—like a millennium or two—it can’t be counted on as a store of value over a more modest period. It’s simply much too volatile.
Gold is as volatile as the S&P 500, says Duke professor and senior advisor to Research Affiliates Campbell Harvey. Its returns don’t generally beat returns from the broader stock market over the long term.
So Why Should You Invest in Gold?
Gold is better understood as a safe haven that investors embrace when times get soupy. For instance, according to Morningstar data, the S&P GSCI Gold Index gained 7.2% in the last three months of 2018, while the stock market declined by nearly 14%.
Even during the most recent bear market, when equities dropped by 33%, the gold index declined by only 2%. The price of gold then shot up over the next few months to record levels.
But gold volatility can go in both directions. Almost a third of fund managers polled in the August 2020 Bank of America Global Fund Manager Survey stated that they believed that gold was overvalued—the highest this sentiment has been since 2011, and up from 0% the month prior.
To put that in context, SPDR Gold Shares, a famous gold exchange-traded fund (ETF), gained 9.6% in 2011 and then 6.6% in 2012, before losing 28.3% in 2013 and then delivering negative returns the following two years.
Gold should be treated as a hot sauce rather than the main course in your investment portfolio.
Why Invest in Bitcoin?
Bitcoin is an electronic payment system that exists beyond the control of any central government. While people have been using gold for exchange for 5,000 years, since ancient Mesopotamia, if not earlier, bitcoin is a much more recent affair. It was invented by a person, or people, known as Satoshi Nakamoto in 2009. It has endured wild price swings during its almost decade-long tenure as a fledgling endeavor.
The cryptocurrency rose to nearly $20,000 per bitcoin by the end of 2017, dropping to less than $4,000 by the end of 2018. More recently, the cryptocurrency bounced around, along with stocks and gold. Its value dropped about in half to roughly $5,000 from the middle of February to mid-March, when investors were first coming to grips with the effects of coronavirus. But it jumped to nearly $11,500 five months later.
These dramatic price swings tend to be greater than what you see with gold, so the digital currency cannot be viewed as a way to store value, as some like to claim—at least not yet.
That said, “the entire crypto ecosystem has matured substantially,” said Stephen McKeon, associate professor of finance at the University of Oregon. “The question has moved from ‘will this survive’ to ‘how big will this get?’”
Fidelity recently announced plans to create a bitcoin fund, although it’s only set to be available to large institutional and accredited investors. Still, these moves may increase bitcoin’s liquidity and help smooth out the wild price swings.
Gold and bitcoin tend to attract investors when the Federal Reserve and other central banks worldwide step in to bail out struggling economies. The reasoning works something like this:
Governments reduce the value of their fiat currencies (currencies backed by the full faith and credit of a nation or group of nations) when they print lots of money and drop interest rates close to zero. Investors respond by putting money into currencies not controlled by central governments.
Moreover, when interest rates are so low, especially when inflation-adjusted interest rates are negative, investors are less enamored with assets that offer yields, like bonds and dividend-paying stocks.
This may induce a bandwagon effect, wherein each new investor keeps the price of a safe-haven asset rising, although they buy at an increasingly high cost. The danger is that some new event or development breaks the momentum, and investors bail out. Then you have the dubious honor of buying high and selling low.
Differences Between Gold and Bitcoin
Gold and bitcoin represent different phases of how people think about “money.” Gold has been a currency for thousands of years, and it retains value partly by investors’ psychological and historical attachment to it. Bitcoin, along with blockchain technology, hopes to one day replace government currencies as how people exchange payments.
As an investment, gold is a more mature asset. As such, it tends to be easier to own. For instance, you can buy SPDR Gold Shares, which have an expense ratio of 0.40%, through your brokerage account. There’s no need to commit to owning physical gold, with its high costs of secure storage.
With Bitcoin, the most common way to invest is to open an account on a cryptocurrency-specific exchange like Coinbase to exchange your dollars for digital currency. You’ll then need to hold it in a digital cryptocurrency wallet.
More broadly, investing in gold reaffirms your belief in the current international financial system, whereas bitcoin is a bet that a more radical alternative is coming.
“The case for crypto is that it is poised to disrupt a large segment of the financial services industry,” said McKeon. “Decentralized finance applications have replicated many traditional business lines such as trading, lending, and insurance.”
Should You Invest in Gold or Bitcoin?
You don’t need to invest in gold or bitcoin to have a well-diversified portfolio. Most investors would do well to ignore their allure and instead own a combination of a U.S. stock index fund, an international index fund, and a bond fund. Most major investment companies offer low-cost options, and you can allocate how much you invest with each based on your age and risk tolerance.
If you want to make a speculative bet on gold or bitcoin, do it with a small, single-digit portion of your assets. There isn’t sufficient evidence to suggest either will deliver more consistent returns than a traditional strategy emphasizing stocks and bonds.