What is a safe-haven asset

What is a safe-haven asset

Safe-haven assets are low-risk resources like gold that tend to provide a good store of value over time. While they may not provide the astronomical returns of some growth shares, they can be vital when defending your portfolio against the effects of economic downturns.

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An introduction to safe-haven assets

Safe-haven assets are resources that have proven to be a good store of wealth over time. These assets tend to maintain their value even during economic uncertainty, so investors often flock to them when financial markets become volatile.

The most popular safe-haven asset is usually gold. Throughout thousands of years of human history, gold has maintained its status as a valuable commodity, making it an ideal place to park your money when financial markets get shaky.

Gold prices will often go up during economic downturns and market crashes as demand for the commodity (from nervous investors) increases. Because the price of gold – and other safe-haven assets – often goes up when the prices of most other financial assets are plummeting, it can provide excellent diversification benefits for your portfolio. 

However, gold is not the only safe-haven asset. Other precious metals, high-quality bonds, certain currencies, and even some shares are also viewed as safe-haven assets, and they can all provide similar diversification benefits.   

Characteristics of safe-haven assets

Stores of value

As we’ve already mentioned, safe-haven assets provide a good store of value over time. This essentially means that they don’t tend to deteriorate in value, at least over the long term.

Gold, and some other precious metals, are good examples of stores of value. Throughout history – and across cultures – these assets have almost always been considered valuable.

Highly liquid

This means there is always an active market of buyers and sellers for these assets, allowing them to be quickly converted to cash in a crisis. This is why real estate isn’t typically considered a safe-haven asset. While property tends to be a good store of value and exhibits many other characteristics of safe-haven assets, a lengthy sale process makes it difficult to convert to cash quickly.

Always in demand

There is a continuous demand for the asset. In addition to making the asset more liquid, strong demand also helps prop up prices. This is a big part of why safe-haven assets can generate such stable returns over time.

Limited supply

Safe-haven assets typically have a limited supply. They might be rare and difficult to find, like precious metals, or their supply might be capped at a particular level by the issuer, as is the case with currencies or government bonds. Scarcity often gives assets higher intrinsic value – once we know that something will only ever be a finite resource, it automatically makes it seem more precious.

Permanence

This just means that safe-haven assets don’t lose their value or relevance through decay or damage. Gold lasts forever and doesn’t diminish in quality over time.

Examples of safe-haven assets

Gold and other precious metals

The most common safe-haven asset people generally think of is gold. Throughout history, gold has always been viewed as valuable and as a signifier of wealth. However, other metals, such as silver, platinum and palladium, are also considered precious. Precious metals are naturally scarce and may have historically been used as currency – in the case of silver and gold or in art, decorations and jewellery.

Currency

Some currencies, notably the US dollar, the Japanese yen and the Swiss franc, have traditionally been viewed as safe-haven assets. These currencies belong to countries with strong economies and a long history of stable interest and foreign exchange rates. The US dollar is also the global reserve currency, which is always in high demand due to its use in many cross-border business transactions.  

Treasury bonds and ETFs

Government bonds are viewed as safe-haven assets because they are backed by the financial strength of the country issuing them. Bonds issued by the governments of developed nations with healthy economies – like the United States, United Kingdom or Australia – are often viewed as almost “risk-free” assets. 

This is because they provide regular coupon payments over the bond's life, plus the return of your invested capital at maturity, and the issuing government is unlikely to default on their interest obligations.

However, it is still essential to keep in mind that factors such as inflation, interest rates, and changes in the credit rating of the issuing country can still cause falls in the prices of government bonds.

Investing in bonds typically requires a substantial minimal investment (think upwards of $500,000), making it difficult for everyday investors to get into the market. However, many exchange-traded funds (ETFs) listed on the ASX provide a more accessible option if you want exposure to bonds. ETFs trade more or less like ordinary shares and aim to mirror the returns of a benchmark index or asset class.

Defensive shares such as utilities

Some shares can also be safe-haven assets. While they still tend to be riskier than other safe-haven assets like bonds or gold, some types of shares can offer protection from economic downturns.

Generally, shares in utility companies, consumer staples, healthcare, and other essential goods and services are considered to be defensive stocks. Demand for these goods and services remains relatively high even during economic downturns and recessions – meaning these companies can keep turning a profit even when times are tough.  

Is cash a safe-haven asset?

Cash might seem like the most obvious safe-haven asset in a downturn, especially when the prices of other financial assets like equities, real estate, or corporate bonds might be tumbling. 

However, cash doesn’t offer any real return on investment, and its value can be eroded by inflation. This makes cash less attractive than a safe-haven commodity such as gold, which tends to increase in price during a downturn, thereby offering some protection against the effects of inflation.

What about crypto?

There has been some debate recently about whether cryptocurrencies can be considered safe-haven assets, with some investors even referring to Bitcoin (CRYPTO: BTC)  as ‘digital gold’.

As with many other safe-haven assets, Bitcoin does have a limited supply. The number of tokens that can be mined is capped at 21 million, and around 19 million have already been mined to date. Many analysts believe this scarcity trait gives Bitcoin intrinsic value, hence the ‘digital gold’ moniker.

However, Bitcoin and other cryptocurrencies are still a relatively new asset class, so their ability to maintain value over time hasn’t been tested. The prices of most cryptocurrencies have also been particularly volatile, which reduces their attractiveness as a safe and stable store of value.

Pros of investing in safe-haven shares

Portfolio protection

Having a portion of your portfolio invested in safe-haven shares can help offset some of the losses you might otherwise experience during economic downturns. You can rest a little easier knowing that your portfolio has some protection built-in for tough times.

Diversification

The prices of safe-haven shares tend not to be highly correlated with the rest of the market. This means that safe-haven shares can offer diversification benefits for your portfolio, reducing the variability of your overall returns and helping you grow your wealth steadily over time.

And disadvantages

Slow or no growth

Although safe-haven shares have proven valuable over the long term, their short-term growth rates are usually pretty low. Investors are compensated for taking larger risks with higher rates of return – but the whole point of buying safe-haven shares is to reduce your risk. This means safe-haven shares may only offer minimal growth potential.

Inflation

Because of their low growth rates, there is the potential that the returns earned from safe-haven shares may not keep up with high rates of inflation – this is particularly true for government bonds and foreign currency ETFs. This means that the actual value of your safe-haven investment may still decline in inflationary periods.

When should you invest in safe-haven shares?

There is no wrong time to invest in safe-haven shares. Think of it as taking out insurance on your portfolio to give yourself a little support if the financial markets become volatile.

The amount of your portfolio you have invested in safe-haven shares and assets will likely change over time. As you get older, your risk appetite will probably decrease – you may wish to preserve your wealth for retirement and shift more of your portfolio into fixed-income securities like bonds. These are more likely to guarantee a stable revenue stream when you are no longer working.

When should you sell your safe-haven shares?

Having some of your portfolio invested in safe-haven shares is always advantageous. They provide diversification benefits and reduce the overall volatility of your portfolio’s returns.

However, when you’re younger and have more time to grow your wealth, you might invest more of your portfolio in riskier assets like international stocks, which may deliver much better longer-term returns than safe-haven assets. Similarly, if equities are going through a bull market, you might miss out on earning higher returns if you have too much of your portfolio allocated to safe havens.

Ensuring your portfolio has the right mix of riskier assets and safe-haven shares is always a balancing act. When buying safe-haven shares, you should consider your overall risk appetite, investing goals, and economic outlook.

Last updated June 2022. Motley Fool contributor Rhys Brock has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Bitcoin. The Motley Fool Australia has positions in and has recommended Bitcoin. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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