When investing in precious metals we are faced with one major decision, should we buy gold or silver? If we invest in the wrong metal at the wrong time, we could miss out on some serious profits, or even worse, we could see our investment dwindle to just a fraction of what it once was worth, while forever waiting for the prices to rise again. For me the solution to this problem is quite easy, and it has all to do with diversification and rebalancing.
Diversification is the mechanism of spreading our investments both over time, investment instruments, and volume, and as I will explain later, this is to our advantage when liquidating and rebalancing our gold and sliver investments.
But how can diversification help me choose if I’m to invest in gold or silver?
One of the ways to implement the principle of diversification is by spreading you investment over several items, instead of only one. This is one of the most common ways of using the principle of diversification within precious metal investing, since the price ration between gold and silver is so big. As you will see in the example below Jill gets 50 times more silver than Joe gets gold.
Lets take the example of Joe and Jill. They both have $10 000 to invest, and their investment portfolio is as follows:
Both Joe and Jill have invested in all the categories except one, gold and silver. We can now observe their different investment tactic in this category and the result of it.
First up is Joe, he’s unaware of the principle of diversification and with the gold prices at the time being $1000/ozt, Joe thinks it’s a smart idea to invest his 10% of the portfolio ($1000) in one single gold coin.
Jill on the other hand has both heard and read about diversification, and its many advantages, so instead of following her friend Joe’s example of putting all his eggs in one basket, she decides to spread out her investments of $1000 over a larger volume. She therefore buys 50 one oz silver coins, with the price of $20 each at the total cost of $1000.
Joe and Jill’s portfolios are scheduled to be rebalanced every month, to keep the correct proportions between the 4 investment categories. Since the last rebalancing neither Joe or Jill has had any increase of asset value in the stock, bond, or real-estate category, but both silver and gold has had an increase of 50%. This is good news for both Joe and Jill, however Joe has a problem with rebalancing his portfolio.
Since Joe only has one gold coin in his gold & silver category, he is forced to sell his entire gold holding of one gold coin, for $1500. He then has to buy back 7 gold coins, weighing 0,1 oz each, at the total sum of $1050. The $450 he made on his gold that month ($1500 - $1050 = $450), he then spreads proportionally over the other categories to keep his portfolio in balance.
For Jill and her diversified silver investment, the story is quite different. The only thing Jill has to do is to sell 30% (15 pcs) of her silver coins, and spread the earnings of $450 proportionally over the other categories, so that her portfolio is in balance. Since Jill only has to sell, unlike Joe who has to first sell, only to then buy back a proportion of what he sold, Jill’s rebalancing expenses is much lower than Joe’s. By using the principle of diversification in volume, Jill has therefore had a greater return on her precious metal investment than Joe.
As we can see from the example above a good way to maximise our return on silver and gold investments is to diversify in volume so that we can rebalance our portfolio for the lowest cost possible.
A rule to thumb I used when I started to invest in precious metals was “Start with small silver investments before I make big ones. First then, will I commence with small gold investments before I increased those to bigger ones”.
