Why gold is a good diversifier for your portfolio

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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.

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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.

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