Pros and Cons of Holding Gold in a Portfolio

A common rule-of-thumb is to have 5% to 10% allocated to gold, Essaye says, depending on a person's risk tolerance, although Self says he's used between 10% and 15%.

Gold makes a good safe haven because it's a finite resource, points out Peter Thomas, senior vice president at Zaner Precious Metals. "You can't print more of it. Period," he says.

In addition to gold stocks and ETFs, investors can hold physical gold in a self-directed individual retirement account. However, these have strict IRS rules, so advisors should work with precious metals specialists to stay in compliance. Thomas recommends investors stick to bullion coins issued by sovereign mints, such as the U.S. Mint or Royal Canadian Mint for IRAs.

Cons

As a high-quality asset, gold isn't immune to panic selling. That happened both in 2008 and in the recent stock market break. In March, gold fell 12.5 percent, although less than the S&P 500's drop of more than 30 percent. However, gold rebounded swiftly and turned positive by April.

Gold pays no dividend, a common strike against adding it to portfolios. However, with interest rates at rock bottom, few safe havens offer much of a yield. Bart Melek, global head of commodity strategy at TD Securities, also notes inflation-adjusted interest rates are negative. Also called "real" rates, inflation-adjusted rates are calculated by using the U.S. 10-year Treasury yield minus the consumer price index. 

"Gold has zero yield, yes, but zero yield quite often is better than negative yields," he says, noting that inflation-adjusted rates are a key determinant for gold prices.

The IRS taxes gold as a collectible, Self says, so the investment gains from physical gold or physically backed gold ETFs held in taxable accounts are treated differently from traditional assets. If gold investments are held for more than one year, the gains at time of selling are taxed at the same rate as ordinary income, with a maximum tax rate of 28 percent.

There is some debate about gold's role as a pure inflation hedge. Gold won its reputation as an inflation hedge during the 1970s. When global central banks embarked on quantitative easing in 2008, gold rallied from $680 an ounce to more than $1,900 by 2011. But Essaye says other assets like stocks and real estate saw greater gains over time. 

That said, Essaye suggests a more diversified inflation hedge is a mix of assets including gold, real estate, very high-quality large-cap stocks and U.S. Treasury Inflation-Protected Securities (TIPS).

Thomas says long-term gold is a store of value, but in the short-term, it can be volatile. "It will build a base, and when it decides to run, it rocks, and it rocks hard. Then the problem arises that you can't buy it when it runs. That's why you buy gold when prices are quiet," he says.  

Essaye says investors who hold gold will need to accept the short-term volatility inherent in the metal and keep a small part of it in portfolios at all times. 

"I view it personally, and I think many advisors see it this way, is that it's a piece of your portfolio that you allocate to it because you know you should. The statistics tell us we should do this because it improves overall portfolio optimization. During times like this, we can look and say, 'hey, you know, it's really doing its job'," he says.