FTSE 100 vs Gold: Optimal Asset Mix For a Portfolio

If you are thinking of investing in gold or precious metal, whether it be an option of hedge against the market volatility or due to fear of economic slowdown, or for any other reason, here we are going to discuss various scenarios that you should be considering before investing.

The Oracle of Omaha “Warren Edward Buffet” long back had said that investing in gold is “silliness” and added that “It won't do anything between now and then except look at you”. It quoted the example of Coca-Cola and Wells Fargo and said that “Coca-Cola is making money and it will continue making money, and Wells Fargo will be making a lot of money”. He said that, it is quite better to have a gannet that keeps dropping eggs rather than a gannet that just sits there and eats insurance, storage and a similar other things like that.

Investing decisions in precious metals like gold coins, gold bars, jewellery and gems, broadly comes with the issues like liquidity, security, storage, and insurance, and what you are going to make out of holding the yellow metal will solely depend on its price movement. Because gold as an asset class does not generate any regular income for investors, whereas there is an ample number of assets classes which earn regular and recurring income for its investors and benefit them from the improvement in the value of their prices.

Through equity investment, be it via direct stocks or through mutual funds, not only you get fractional ownership in the company, but you also receive benefits like dividends. When you allocate money in fixed income securities, you are primarily lending someone, and in lieu of that you earn interest upon it, in case of real estate you get rental income. But gold, on the contrary, eats up your money in the form of storage and other expenses and sits there with no guarantee of returns or benefits.

The basic principle of the time value of money does not fit well in the case of gold investing. As per the concept of the time value of money, money works for you even when you are sleeping, or money uses income, that you receive. If someone is using your money, he should pay you the uses expense upon it, be it in the form of interest, dividend, rent, etc. But gold investing does not pay any uses expense to the investors and return upon it solely depends upon the capital appreciation.

Further, anything that takes place in the economy be it inflation, GDP growth or contraction, monsoon, war, political uncertainties will have a bearing on the gold prices, which often results in high volatile swings in the gold prices.

Equity vs Gold

As we know that, gold prices are inversely proportional to the equity returns and if we throw some light on the historical performance of the gold as an investment asset class against the equity investment, we will conclude that equity performed substantially better than the gold asset.

But recently we have witnessed high volatility in the equity markets across the globe; now the question arises in the realm of this unpredictability, should we consider gold investing as a hedge against volatility in the stock markets?

Many researchers and analysts are comparing the recent doldrum with the 2008 financial crisis, but it is not something that will repeat very often, and also during the financial crisis, there was a weakness in both equity and debt instruments. It was the biggest reason because many investors just flocked into the gold investing at that time, but the current scenario is different from the 2008 crisis, and everywhere there is a slew of stringent measures being taken by the respective central banks and the governments as well. Therefore, following the same trend and flocking in gold investing will probably not serve the purpose for the investors this time.

So, if you are considering gold investing, you should not allocate more than 2-5% of your total assets towards the gold investment in the portfolio, particularly when you have a source of regular income. For those who don't have a regular source of income, gold allocation in their portfolio should not be more than 10% for them.

Many widely famous financial advisors suggested their investors that create a minimal exposure in gold for your portfolio and that too for the sake of diversification and instead focus on a concentrated portfolio of equity stocks and investment-grade fixed-income securities.

The FTSE 100 Index

The broader index of the UK FTSE100 comprises of 100 large companies with high market capitalisation. It is also regarded as a global benchmark index because the majority of its constituents are global companies, they have significant presence worldwide, and their top line is widely diversified. Therefore, when you are buying the stock of FTSE 100 companies, you are not just investing in UK stocks, but you are adding global stocks into your portfolio.

The present ongoing political crisis in the UK is really offering several golden opportunities for the investors, as UK stocks are available at a cheaper valuation against the other developed economy’s stocks. Let’s take the example of the US market, the broader index of the United States S&P 500, which reflects a portfolio of 500 large companies is trading at a Price-to-Earnings ratio of 20x with the dividend yield of 2.47%, whereas the FTSE 100 index of the UK is trading at a Price-to-Earnings ratio of 14x with a dividend yield of 4.83% respectively.

Also, the UK stocks have not participated in the recent bull run because of some of their home-grown problem like Brexit. In absolute terms, over the past five years, the S&P 500 index of the United States has handed approximately 44.15% return, whereas the broader index of the London Stock Exchange the FTSE 100 index, has delivered just 5% in the same period of time.

5-year absolute price return of the FTSE 100 index and S&P 500 index. Source: Thomson Reuters.

Once the Brexit mess gets resolved, we believe that stocks from the London Stock Exchange will deliver the best return against the global developed economy's stocks. Also, the dividend yields of the UK stocks are relatively very high, which suggests possible chances of decent dividend income and capital appreciation as well in the mid to long run.

FTSE 100 Dividend Yields vs Bond Yields

As discussed above, the FTSE 100 index is offering a higher dividend yield against the global peer benchmark indices, but if we look at the US 10 Year Bond Yield, it was quoting at 1.43% (as on August 29, 2019, at 11:16 AM GMT). The dividend yield of the FTSE 100 index is approximately 3.4x of the US 10 Year Bond Yield and approximately 11x of the UK 10 Year Bond Yield. Government Bond Yield. Which reflects investment in FTSE 100 stock makes a rationale sense as it is offering higher yield on your investment plus carrying potential to provide decent capital gain as well, in the mid to long-term time period and also as the stocks there in UK market are available at a cheaper valuation in terms of PE(x) multiple.

Therefore, at this juncture, equity as an asset class is offering more valuable bets than the other asset classes like gold and bond in the UK. As bond yields are plunging and gold cannot provide recurring income; therefore, at present equity is best investment class available for the investors in the UK market.

However, many investors are still not getting courage to invest in London equities at this point in time, where risks mainly are related to Brexit. But again, to sum-up the article will put a quote from Oracle of Omaha “Warren Buffet”: “Be greedy when others are fearful and be fearful when others are greedy”.