According to Investopedia, hedging in finance is taking a compensating position with an investment or asset to reduce the effects of future price risks.
In simple terms, a hedge is an investment that has a better chance of moving up in value when other portfolio assets take a downturn in price.
Let’s look at why and how gold works as a hedge against inflation and other financial adversities.
Why Is Gold a Hedge Against Inflation?
It’s common knowledge in investor circles that gold has an inverse relationship with the stock market – when the price for one is up, it tends to be down for the other.
This is why gold has a reputation for being a smart investment and a reliable way to diversify portfolios. Investing in gold also functions as a hedge against financial risks in a couple of ways.
Gold operates as a form of protection when the value of U.S. currency declines. It’s typically less expensive to hold than stocks and tends to rise in value when the dollar slips.
Gold is also a good hedge against inflation due to its track record for staying stable when the cost of living rises. In fact, over the past five decades, gold has risen when inflation caused the stock market to dip.
Hedge Your Portfolio with Gold
You can use gold as a comprehensive hedge in a widely diverse portfolio. Thanks to the inverse relationship gold has with other types of assets, many investors combine it with stocks and bonds to limit their exposure to volatility and risk.
Physical Gold as a Hedge
Adding physical gold to your portfolio can be done through private or government mints, precious metal dealers, or jewelers.
Some of the most popular physical gold assets include coins, bars, or fractional sheets of bullion.
As with any investment, you should make sure you’re working with a reputable gold seller who will ensure you receive nothing but 999.9 fine gold bullion.
Gold ETFs as a Hedge
Another common way to invest in gold is with exchange traded funds (ETFs). Gold ETFs are traded on an exchange market, and shares are backed by a store of physical bullion.
However, most ETFs don’t work as a substitute for physical gold – as an investor simply own shares of a gold-backed ETF and won’t be able to access the bullion that represents the investment.
Gold Futures as a Hedge
A futures contract is an arrangement to sell or buy gold on a date in the future for a pre-determined price. In most cases, no physical assets exchange hands in a gold futures deal.
This gold investment option can be complicated and lengthy, usually requires a large upfront investment, and comes with a list of additional costs. All of this makes gold futures a better choice for highly experienced investors.
Of course, how you choose to invest in gold is entirely up to you. No matter in what form, investing in gold as a hedge against inflation is a smart financial choice for most investors.