Investors’ fears about an unpredictable future will play a role in the success or failure of their investment experience. Strangely, some of the most successful investors might be those with brain damage, at least according to The Wall Street Journal article “Lessons from the Brain-Damaged Investor.” Professor Baba Shiv of Stanford University conducted a study in which participants who had a brain lesion that eliminated their ability to feel emotion, were compared against “normal” brain people in an investment game. Each person was given $20 and asked to make a $1 bet twenty times. Each bet was on the toss of a coin where a win would produce $2.50. A loss simply meant you lost your dollar. In each round, they could invest or not invest. If they chose not to invest, they kept their $1 and proceeded to the next round. The “gamble” was always the rational choice, but the results showed that when a normal-brain investor lost one bet, he only invested 41% of the time in the next round, while the brain-damaged people invested in 85% of all rounds following a loss.
With consumer fears at a high, there is a real hunger for any investment that hedges against another downturn – enter gold. It begs the question: Would the brain-damaged investor sell his stocks to buy gold? Gold investing, all by itself, amounts to speculating on future price movements, and is a bet as to whether or not some future economic crisis is around the corner. Unlike owning your share of a company in the form of a stock, gold produces no “expected earnings,” and there are additional costs with having to store it, secure it, etc. There is no inherent reason gold should outperform stocks and it holds the title for for going 25 years with virtually no appreciation (1981 to 2006). Since 1973, gold, while being a more volatile asset class than the S&P 500, has underperformed the S&P. However, it has significantly outperformed the S&P over the past 10 years.
Diverting a larger percentage of one’s assets from stocks to gold would be tantamount to “buying high,” given gold’s recent above-average returns. This runs counter to a disciplined system of “buying low and selling high,” also known as “rebalancing.” According to The Investment Answer, annually rebalancing a portfolio composed of 50% US Stocks, 20% international stocks and 30% bonds added 0.88% annually in returns with a lower standard deviation for the 20-year period ending in 2009 when compared to a portfolio which started out identical but was never rebalanced.
At Abacus, every asset class has a specific purpose. Stocks and real estate should drive a portfolio’s appreciation over the long term. To insure against sudden market declines, we prefer cash and high quality short-term bonds. Finally, to hedge against inflation and other global risks, such as war, we include commodities, which include precious metals (yes, gold). We feel that gold has already moved to reflect the current sovereign risk and fear of a currency collapse. Is there officially a “gold bubble” forming? Bubbles aren’t generally called bubbles until they burst, so only time will tell. In the meantime, we strongly discourage investors from putting too many eggs in one basket, and we believe that every Abacus client has just the right amount of golden eggs.
May your money wisdom increase.
