The price of gold has surged in recent months and investor interest in the yellow metal has increased significantly as a result. According to the World Gold Council, around $6bn flowed into gold-bullion backed exchange-traded funds (ETFs) in August this year.
Having a little bit of exposure to gold in your portfolio isn’t the worst idea, given its status as a ‘safe-haven’ asset. If stock market volatility returns, gold could provide an element of portfolio protection as it often rises in price when economic uncertainty is high.
It also has a low correlation to other assets such as equities, fixed income, and property. However, if you’re looking for long-term investments for the core of your investment portfolio, I think there are better options than gold.
Gold pays no income
One of the main problems with gold as a long-term investment is that it doesn’t pay you any regular income. As Warren Buffett says, gold “doesn’t do anything but sit there and look at you.” This is an issue because, with no income, you can’t capitalise on the power of compounding (earning interest on your interest). Read any basic financial book and it will tell you that compounding your money is the secret to building wealth over the long term.
In addition, because gold pays no income, you can only profit from it if its price rises. While the price of gold could rise in the future, it could just as easily fall. Take a look at what happened to the gold price between 2011 and 2015 – it fell from near $1,900 to around $1,100, a decline of around 40%.
Those who bought near the all-time high in 2011 are still be sitting on a loss today. When you invest in gold, you have to hope that sentiment toward the yellow metal remains bullish.
One asset class that I believe offers many advantages over gold is dividend stocks.
Unlike gold, dividend stocks pay you income on a regular basis. This means that you can compound your wealth by reinvesting your dividends in order to generate more dividends in the future.
Moreover, with dividend stocks, there are two ways you can potentially profit – from capital gains and also from the dividends. As a result, it’s still possible to make a profit even if the stock market is falling.
Yet another key advantage that dividend stocks have over gold is that you can potentially live off the income stream generated (and it can be tax-free if your dividend stocks are held in an ISA). By contrast, if you own a gold bullion bar or even a gold ETF, selling a small proportion of your investment for income purposes could be a challenge.
Right now, there are some really attractive yields on offer from FTSE 100 dividend stocks. For example, Royal Dutch Shell currently offers a prospective yield of around 6.3%, while Legal & General Group offers a yield of around 7.5%.
Building an income-generating portfolio has never been easier. While gold is making all the headlines at the moment, I’d urge you to take a closer look at dividend stocks if you’re serious about building your wealth.
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Edward Sheldon owns shares in Royal Dutch Shell and Legal & General Group. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.