Why gold is a good diversifier for your portfolio



But gold also does two other things, which make it worth having in the portfolio in small amounts:

1. It’s diversifying as it behaves differently than paper assets

Market Realist – The graph above shows the correlation coefficient of gold (GLD), the S&P 500 (SPY)(IVV), the iShares Emerging Markets Fund (EEM), and the SPDR Barclays Capital High Yield Bond ETF (JNK), considering monthly returns for ten years.

Article continues below advertisement

The correlation coefficient, which always lies between -1 and 1, is the extent to which two securities move with each other. A correlation coefficient of 1 means that the two securities move in absolute tandem with each other. A coefficient of -1 means the two securities are inversely related. A coefficient of 0 means the two move in random directions. It’s the most desirable as far as portfolios are concerned.

As you can see, the correlation between gold and the S&P 500 is 0.1. Between gold and junk bonds, it’s 0.1. And between gold and emerging markets, it’s 0.3. The correlation between gold and the S&P 500 is much lower than between the index and emerging markets, which stands at 0.8, surprisingly. The former is also much lower than the correlation between the S&P 500 and junk bonds, which also stands at 0.8.

This means that gold adds massive diversification benefits to a portfolio containing the other three. So it needs to be in your portfolio—at least in a small amount.

Please read the next part of this series to learn the second reason why gold deserves to be in your portfolio.


More From Market Realist