Equity markets have been at their volatile best over the last few months. This is not the case just with domestic markets; conditions in global markets are as turbulent. Also economic woes continue to plague the US, making investors even more nervous about investing in equities. With investors abandoning equities, gold which has traditionally been a store of value, once again occupies center stage.

Mainly for these reasons gold is at an all-time high and has expectedly caught the fancy of investors. As equity markets turn more volatile, investors are venturing into assets like gold for that extra return. The moot point is; are they investing in gold for the right reasons? For investors oblivious to how asset cycles work, rising gold prices look like an opportunity to make easy money.

Since equity markets have fallen sharply, leading to significant losses, investors have now shifted their attention to gold which has appreciated sharply over the last few months. Investor's rationale for investing in gold is far from what it should be. Rather than viewing it from an asset allocation perspective, gold to them appears as the most profitable investment proposition at present. So they are now over-invested in gold like they were in equities earlier.

• Gold vs BSE Sensex, click here to find out which has done better

We, at Personalfn, have always believed that investors should invest in gold mainly for three reasons, all of which are inter-linked and revolve around the fact that gold is different from other asset classes:

1. Hedge against inflation

Before we venture into how gold can be a hedge against inflation, let us first understand what 'inflation' means. Inflation could be explained as the general rise in prices. This has a corresponding impact -- a decline in the value of the currency as you start to pay more for the same product/service. So, if you were paying Rs 40 per litre of petrol, you start to pay Rs 50 for the same quantity. This erosion in the value of the currency (i.e. the Rupee) is something investors should ideally guard themselves against. One way of 'guarding' your wealth is to hold it in an avenue that preserves its worth. Gold, as an asset class, has historically proved to be a good hedge against inflation.

2. Adds stability to the portfolio

Gold can have a stabilising effect on your portfolio. This flows from the previous point. As we have seen, gold 'behaves' differently than other assets. When equities are volatile, gold can play the role of an anchor in your portfolio. Most investors suffer heavily during stock market volatility because they are over-invested in equities. During a stock market rally it is easy to get carried away by a sense of feel-good. Not only are existing equity portfolios bloated, fresh monies are also earmarked for equities. When markets collapse, investors are left stranded without a anchor; an asset like gold can play this role well provided investors were prudent enough to have invested in it before the crash (and not after).

3. Asset allocation

Asset allocation means diversifying your money over various asset classes like real estate, equities, debt, cash and gold. We have explained this briefly in the previous point. Prudent asset allocation de-risks the overall portfolio and improves its performance over the long-term. Poor performance of any one asset does not jeopardise the entire portfolio. At Personalfn, we recommend that investors pursue a well-defined asset allocation plan, which must be re-balanced at regular intervals.

• Want to get your asset allocation right? Click here!

What you must know before investing in gold

Although prudence demands that you invest a portion of your assets in gold, don't go overboard. While there are several benefits of investing in gold, some points are noteworthy:

1. Unlike other assets, such as debentures, gold does not provide regular income.

2. Investing in gold does not provide any tax benefit. On the contrary, sale of gold results in a tax liability.

3. Purity of the metal is always a worry. There is a good chance that you might not get the purity that was promised. At the time of selling the substandard gold, you will have to settle for a lower price. To avoid this problem, at the time of buying, always insist on a certificate authenticating the purity of gold.

4. There is an extra cost involved in preserving gold. If you have physical gold, you may need to invest in a bank locker. If you buy gold over the stock exchange (i.e. gold exchange-traded fund), then you will need to maintain a demat account.

Now the big question. . .

How much gold should you own? That will depend a lot on your risk appetite and long-term investment objectives. Having said that, we believe most investors should have no more than 5 per cent of their assets in gold. This may sound like a tame number in these times when gold is on a high, but over the long-term being over-invested in gold can pull down your over-all portfolio.