You Are About to Make a Bad Investment

Don't do it ...

Don't you invest in that just because it's popular right now. I'm warning you.

Across 10 asset classes, over a near-40-year time horizon, and in increments of three, five, and 10 years, there's one investment vehicle that made for a total loser -- a dud.

It's gold -- and if you're considering it, let me explain why you need to bypass it and move on. Although the precious metal may well be one of your favorite items in the vault, as an investment, it is just plain lousy.

Bring on the hate mail
You needn't take my word for it -- Investor's Business Daily pulled the data from a study conducted by two Merrill Lynch strategists. And today, very few have the gumption to say that gold is simply not worth your time. Why?

Perhaps because, as IBD wrote, "in one recent five-year period -- the one ended Feb. 7 -- [gold funds] leave a different impression. Gold funds tracked by Lipper Inc. cranked out an average annual return of 25.45% vs. U.S. diversified stock funds' 12.60%."

You can bet your bottom dollar those returns have a lot to do with the metal's current popularity. As usual, investors are chasing performance. While gold funds and industry giants such as Goldcorp (NYSE: GG  ) are doing fine these days, four decades worth of data demonstrate that gold is a riskier and lower-returning investment than pretty much any other.

Higher risk/lower reward
The two folks at Merrill hit the nail right on the head when they said, "Investors often lose sight of longer-term historical investment results, especially during short-term periods of extreme volatility and trending markets."

Bingo!

Short-term, return-chasing investing is precisely what is driving this modern-day gold rush and that is exactly why you should be looking elsewhere. But before I get to where exactly, it is important to understand just what the gold bulls are thinking.

Looking through the other side
Supporters of gold like to note that the past 40 years were an unprecedented period of growth in the American economy. It was the time of Microsoft (Nasdaq: MSFT  ) , Wal-Mart (NYSE: WMT  ) , and other companies that revolutionized or invented their industries alongside booming growth in our domestic economy -- the likes and returns of which we'll probably not experience again. OK, fine.

Gold bulls go on to suggest that there is no reason to believe that the next 40 years of equity returns will look anything like the prior 40. Our economy is too big and too developed ... and that's probably true.

It's all about risk
According to them, we're entering an era of massive economic risk thanks to our miserable levels of national and personal debt. As evidence, Citigroup (NYSE: C  ) , a cornerstone of our nation's financial industry, has nosedived some 55% since 2007. Hey, don't forget about political risk from terrorism, a more competitive China, and the end of cheap fuel. Risk is everywhere.

To that I say: Where did the risk ever go?

Wasn't it a difficult choice for Americans to buy shares of General Electric (NYSE: GE  ) during the height of the Cold War alongside the underlying threat of nuclear war? Yet investors that stuck with their guns on GE made 13,476% (16% annualized) compared to a measly 375% (4.8% annualized) on gold since 1975.

With all the bear markets, through the oil crises, Black Monday, the implosion of the dot-coms, stagflation, and all the economic risks you can think of, do you know which asset class was the only one that lost money in a 10-year time frame? Yup, our favorite precious metal: gold.

Goldfinger will not be pleased
I'm not bashing gold simply to bash. In fact, it isn't the worst idea to put a small slice of your portfolio in gold to diversify in case I'm wrong. But there's a better solution for the rest of your money: Go with the asset class that has consistently demonstrated the highest returns on investment with some of the lowest elements of risk: small-cap stocks.

This isn't my own unproven theory -- the data comes from the same study I mentioned before. Generally, equities trump just about every available investment alternative you have. But small caps in particular demonstrate significantly high returns with comparatively low risk. What more do you need?

The truth will make you rich
To find the best of the small-cap world, you've got to think like a great small-cap stock. Remember: the giants of industry you know today once resembled the Netflixes (Nasdaq: NFLX  ) and the Under Armours (NYSE: UA  ) of the world we know now.

That's because many of the world's best businesses -- like Netflix and UnderArmour -- started small with great ideas on top of cash-generating business models with entrepreneurial owners at the helm. And there are plenty more out there where those came from.

If you want to be on the side of returns that smash gold in the long run, then you must allocate toward these types of stocks.

Need some ideas? Consider our Motley Fool Hidden Gems small-cap service, where our team's picks have beaten the market by 22 percentage points on average. Click to get all of our research and recommendations free for 30 days.

Fool analyst Nick Kapur used to have a gold class ring, but, sadly, lost it. He owns no shares of any company mentioned above. Netflix is a Stock Advisor recommendation. Under Armour is a Rule Breakers pick. Wal-Mart and Microsoft are Inside Value recommendations. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 03, 2008, at 3:21 PM, sumatrajoe wrote:

    Gold is a bad investment but a good hedge. In case of a catastrophic financial disaster, when paper is worthless, gold in your possesion will still be worth something.

  • Report this Comment On March 06, 2008, at 7:16 PM, ddepperman wrote:

    I have read so many warning articles from investment advisors over the years, including MF's. I have followed your and other's advice, and I have made many crappy choices on that advice, as I see have people who leave messages on the boards. If truth be told there are ways to make $ on gold even now, esp in light of the economic news I have been hearing for at least a year and which you never seemed to have been aware of. I also have a friend who made all the 'wrong' choices in investing including buying gold at about $300/oz. His advisor told him he was making a big mistake. Now she is asking him for ideas(!)

    You have to educate yourself, as rigorously as possible, always be sceptical, keep a finger to the wind, and learn how to sit on your hands when good advice comes your way(but not on your thumb).

    Had I been the possessor of $10,000 when I first heard of The sage of Omaha, when I read The Money Game(pseudonomously by "Adam Smith") in 1971 I would have foolishly put it all in Berkshire, and then I'd now be sitting on my money bin like Scrooge McDuck used to do in the comics. Har Har Har--Damnitall.

  • Report this Comment On July 08, 2008, at 8:09 PM, XMFSinchiruna wrote:

    Gold's going to $1,650, Silver to $50 and beyond. I suppose if you held straight through the top of this long-term secular bull market, once the $20 trillion in derivatives have finally de-leveraged and the USD finally bottoms out into a clear technical reversal... if you held through all these events and then for years more to follow... then yes, gold could LOOK like a very bad investment. But if you increase your gold allocation during a secular bull market and use discipline and critical independent thinking to determine your exit point/points as the cycle matures, gold will be one of the very best investments available throughout the difficult times ahead.

  • Report this Comment On September 14, 2008, at 11:08 PM, XMFSinchiruna wrote:
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