Although I still have work to do to get my target asset allocation in line, I have been wondering about ways to further enhance my portfolio and did some research on precious metals as an asset class. I was intrigued about it again when leafing through my copy of The Intelligent Asset Allocator and decided it was high time I did a post on it. It is not an asset class that is talked about very often![ad#tdg-embedded]

What Precious Metals Are

Precious metals is best defined by quoting the following blurb from investing supersite Investopedia :

A classification of metals that are considered to be rare and/or have a high economic value. The higher relative values of these metals are driven by various factors including their rarity, uses in industrial processes and use as an investment commodity.

Precious metals include, but are not limted to: gold, silver, platinum, iridium, rhodium and palladium.

From an investing perspective, and the way I am looking at it, is not to go out and buy my wife a new gold necklace but rather to invest in companies or ETFs that track the precious metals market.

Why Use Precious Metals

There are a couple of reasons an investor would use precious metals in their portfolio. The first is that precious metals can provide enhanced returns to a portfolio. The extra risk that it brings to a portfolio can provide increased returns. The second reason to use precious metals is that they are typically uncorrelated with the financial markets. In other words, when the market is tanking precious metals have been shown to go the other way up. And the third is that precious metals can be good in times of inflation. When prices go up, so to does precious metal prices. There are a lot of people saying we will be going into a period of inflation so the timing might be right (but we dont time the market, right).

The Risks of Including Precious Metals

Just as there are some positives with the precious metals market, there are certainly some real big negatives. Those enhanced returns I just spoke about are coupled with huge risk. This risk leads to huge volatility that precious metals brings to a portfolio can test even the most seasoned investor. It pays to not have too much allocated to this asset class.

Example Funds

Thanks to Brandon on Twitter. I was directed to this huge list of indexes and funds that track the precious metals markets. At first it was actually a bit overwhelming as the list was much bigger than I suspected it would be. However, I simply went to another fund Brandon suggested the Vanguard Precious Metals and Mining Fund to see what it looks like. This fund tracks both the mining companies responsible for finding and developing the metal but also invests up to 20% in actual metal bullion and coins. I think it would be a good place to start for the average investor.

My Decision

This initial bout of research has lead me to a decision with respect to including it in my portfolio or not. I will include it down the line, however because my target allocation still needs some work I do not want to add another asset class to direct money to. I need to get the risk profile of my portfolio down with the inclusion of more fixed income so that is my first priority. Adding a more volatile and risky asset class would not help and opens me up to issues with emotional reactions to a wildly swinging portfolio.