Equity MFs v/s Gold Investments

I currently have about Rs 4.2 lakh invested in tax-free bonds and debt mutual funds. I had tried trading in stocks but lost money and decided to switch to gold last year as I thought this option was safer. I have also invested Rs 2.8 lakh in Reliance R* Shares Gold ETF. After the recent fall in gold prices, I am worried about my investments. Please advise me on my portfolio and suggest how I can get high returns over the next five years.

- Soham Inamdar

I am glad you are reviewing your investments. Your overall portfolio is quite risky as you have 40 per cent invested in gold! Large investments in gold are not really safer than equities.

The prices of gold fell dramatically in April 2013, partly because of speculations that Cyprus was planning to sell its gold reserves to fund its bailout. In the past, gold has acted as a hedge against inflation and the dollar. However, the metal is losing its value as an inflation hedge as inflation rates are modest in most developed countries. Gold prices may also be adversely affected by lower demand or excess supply. Demand and supply are influenced by variables including economic growth, jewellery demand, central bank reserves, mine production and the demand from India and China (the world’s largest consumers of gold).

*Refers to gold priced in INR
Source: World Gold Council

As the chart shows, equities generally outperform gold in the long run. The Sensex has also generated higher returns than those offered by gold in seven out of the last ten years, as the figures in the table demonstrate:

Investors in equities can benefit from dividends as well as from capital appreciation. Gold does not generate interest or dividends. Unless you wish to accumulate physical gold, you should redeem some of your holdings in ETFs and invest in large-cap equity mutual funds.

Mutual funds are designed to protect investors. Investments in equity mutual funds have several advantages over investments made directly in equities. The fund managers can track macroeconomic and company-specific data easily and efficiently. Hence, they are more likely to identify top-performing companies than individual investors. Investing in equity mutual funds also allows you to diversify your portfolio effectively and at a lower cost.

Large-cap funds are relatively less volatile than their small- and mid-cap counterparts and have lower downside risks. The large-cap funds shown in the table invest in shares of ‘blue-chip’ companies. These companies are well-established, with strong financials and steady growth prospects. The funds are the best performers in their categories and have consistently outperformed the Sensex. Over the last year, these funds have also outperformed the R* Shares Gold ETF.

You should rebalance your overall portfolio so that you have the bulk of your corpus invested in fixed income and equities. As shown in the table, you could reduce your fixed income exposure to Rs 3.5 lakh and invest about Rs 3.15 lakh in large-cap mutual funds. You could retain some of your investment in gold, as this will add diversification to your portfolio, but limit your exposure to gold to about five per cent of your portfolio.

This proposed allocation is geared towards debt and relatively safe equities. Historically, over a five-year rolling period, the Sensex has generated positive returns 92 per cent of the time. The recommended portfolio will enable you to benefit from favourable movements across three different asset classes. This allocation should help you earn high returns and simultaneously restrict volatility over the next five years.