The Surprising Truth About the
Returns from Owning Gold

"Gold is the smart investor's choice... Some forms of gold are among the most protective and profitable investments over the past three decades. It's true! Investment quality gold has actually outperformed stocks!" So goes a current ad for gold, and you've probably heard similar variations on the theme as the gold promoters are out in full force. What should we make of their claims? And what should your response be as an individual investor?

Before getting into the merits of gold as a long-term investment, let's review its recent history. Gold has been red hot, with the price of an ounce of gold roughly doubling over the past four years. Obviously, that's significantly better performance than most other types of investments over that time span. So there's no denying, a trade in gold a few years back when its price was at a 20-year low would have been very profitable.

But what about the longer-term merits of gold as an investment? Here the picture gets a bit cloudier, as gold marketers often try to focus on absolute prices, ignoring the significant effects of inflation. That way, they can stoke excitement over the fact that the price of gold is higher than at any point since the early 1980s. Adjusting those prices for the tenacious effects of inflation tells quite a different story however, and brings us to the heart of the matter in evaluating gold as an investment.

The chart above shows the "real" return of gold over the past 200 years. ("Real return" simply means its return after taking inflation into account.) It's a telling picture. Far from being one of the "most protective and profitable investments" available, adjusting for inflation reveals gold's true virtue: as a store of value, rather than an investment. Adjusted for inflation, a dollar invested in gold at the beginning of the 19th century has been worth roughly a dollar ever since. There have been highs and lows ($4.26 in 1980, $0.58 in 1969, both reflecting government interference with the gold market as much as anything), but what's rather remarkable is the consistency with which gold has stayed at roughly the same inflation-adjusted value. This has been true for centuries—it's said that an ounce of gold has been able to purchase a man's suit of clothing since Shakespeare's time, and that's still the case today.

As an investor though, you should have much higher aspirations than merely keeping up with inflation. After all, that's just treading water—you haven't gained any purchasing power. You can do better. Much, much better. According to Jeremy Siegel, a dollar investment in gold way back in January of 1802 would have grown to just $1.62 by the end of 2005.* Contrast that with the growth of other investment types: T-bills would have grown to be worth $293, bonds to $1,083, and a dollar investment in stocks would have grown to be worth a staggering $666,180. Not a thousand times better than gold. Not 10,000 times better than gold. But more than 400,000 times better than gold! So much for the claim that investment quality gold has actually outperformed stocks.

Over short time periods that can happen, but it's clearly the exception rather than the rule. What a longer-term perspective reveals is that over time, gold provides short bursts of superior performance, only to settle back to its long-term trend of roughly keeping pace with inflation. Sure it's exciting to think of doubling your money in four years as gold has done lately. But what about the 20 years prior when gold consistently failed to even keep up with inflation while stocks were soaring?

The point is that gold isn't so much an investment as it is a trading opportunity. If you're a trader or speculator, with knowledge of all the factors that influence the price of gold, and the dedication to watch your trades closely and dart in and out of the gold market, it may hold some appeal. But if you're an investor, whose desire is to make a reasonable return on your money over time without a huge time commitment, gold is probably best left out of your portfolio.

Sure there will be periods when gold races ahead of traditional stock and bond investments. But when you hear the clever commercials of the gold promoters trying to insinuate that recent short-term price movements are anything more than that, just smile and know that the path to long-term increase is more likely to be found if your pockets aren't filled with gold.

*Jeremy Siegel is a professor of finance at the Wharton School of the University of Pennsylvania. All of the data used for the chart, as well as the figures quoted in this article, are from Professor Siegel.

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