You don’t protect yourself by investing only in dollars or gold; understand – 05/06/2023 – From Grain to Grain

You’ve probably heard someone say that to protect yourself, you should buy dollars or gold. After repeating it so much, many assume it to be true and, as soon as uncertainty increases, interest is boosted. Part of the blame lies in a failure to interpret financial concepts. I explain where the confusion is and what trap you need to be careful not to fall into.

Claims that gold and the dollar are assets for protection end up encouraging investors to inadvertently invest. The flaw lies in the interpretation of the theoretical concept of diversification.

Usually, it is generalized that to diversify is to protect yourself. This deceives investors who end up losing money and becoming frustrated with the “protection” results.

When you diversify your portfolio into just a few risky assets, it doesn’t mean you’re hedging.

The act of diversification occurs when you add assets with correlation tending to the negative. Assets with a perfectly negative correlation, that is, a correlation equal to -1, are those that whenever there is a positive variation in one, the other suffers a negative variation.

In this way, the opposite movements of the assets reduce the total volatility of the portfolio. Therefore, the concept of protection in relation to the portfolio occurs because you already had risky assets, but added another risky asset such as the dollar that has an opposite movement.

The dollar has devalued in the last 3 years and gold has fallen in the past year and the year before.

Therefore, if you are a conservative investor and are used to the CDI, you will quickly understand that investing only in these risky assets is far from being stable like the CDI.

Therefore, investing in them will not necessarily protect your wallet. On the contrary, it may result in devaluation and will certainly produce greater monthly fluctuations.

Both gold and the dollar have high volatility. Volatility is the dispersion of returns relative to their average return. Their volatility is similar to that of the stock exchange. Therefore, if you only add these assets to your portfolio, you will only be increasing risk and not decreasing it.

The concept of protection for these assets only occurs when you have a portfolio with risky assets such as stocks and you want to reduce the portfolio’s total fluctuation. Only then would you be taking advantage of the protective power of diversification.

For example, the dollar has a negative correlation with Brazilian stocks. Thus, adding dollars to a stock portfolio tends to reduce the portfolio’s overall fluctuation.

Also, it is not appropriate to think about purchasing power protection for these assets, as purchasing power protection occurs when investing in assets referenced to short-term inflation in their currency, that is, the Real.

Gold’s 10% appreciation this year attracts investors who imagine that in addition to “protecting” their portfolios, they can still earn. Over the past 15 years, gold has appreciated by an average of 3.9% per year. If you buy now after the appreciation, you run the risk of entering the price peak. So I would only be left with the loss.

Before rushing to popularly known as protective investment alternatives, reflect on which risk you want to protect yourself from and how the inclusion of this asset in your portfolio should contribute to the total return on the price you are acquiring.

I am in favor of diversification. However, it is necessary to understand what it can result in return and volatility for your portfolio and it must be well structured so that you do not end up raising the risk when you intended to protect yourself.

Michael Viriato is an investment advisor and founding partner of Investor House.

Talk directly to me via email.

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