Gold is a precious metal like silver or copper, although its shiny appearance and valuable physical properties have made it one of the most desirable elements. Used in everything from jewelry to electronics, investors have sought gold to preserve (or increase) wealth for longer than any public company has existed. Gold has a diverse number of investment vehicles but also plenty of unique risks that you must understand before investing.
Different Forms of Gold Investing
If you want to invest in gold, you'll have four main options: physical gold, gold mining companies, gold funds, and gold futures contracts. Let's look at the pros and cons of each type to help you determine the best fit for your portfolio.
Physical Gold
The oldest form of investing is still quite prevalent today: buying and holding physical gold. Physical gold comes in various forms. You’re likely reading this article on a smartphone or device that uses physical gold as an electrical conductor. Gold coins, bars, jewelry, and bullion are some everyday items investors use to add physical gold to their portfolios.
Buying and holding physical gold might seem like a good way to simplify the investing process, but there are some complications with owning and storing physical gold. For starters, physical gold must be stored in a safe location, which often comes with recurring costs if you own a significant amount. If you store gold yourself, you must invest in a safe or other secure receptacle.
Physical gold is also highly illiquid; you can’t buy and sell gold on an exchange like stocks or futures contracts, although you can buy gold bullion at Costco Wholesale Corp. You must sell physical gold at a jeweler, bullion dealer, online marketplace, or another local collector.
Finally, taxes can be a significant headache when investing in physical gold bullion. The IRS considers physical precious metals like gold and silver collectibles, not securities. Collectibles held for less than a year will be taxed at the ordinary income rate like stocks, but the long-term capital gains rate for collectibles is a flat 28%. Obviously, 28% is much higher than the long-term capital gains rate on securities like stocks, which can be 0%, 15%, or 20%, depending on your income level. If minimizing taxes is your primary concern, owning physical gold is the least efficient way to make a gold investment.
Gold Mining Stocks
If you don’t mind a little risk in your portfolio, gold mining stocks could be a path to outsized returns. However, these stocks are volatile, and gold miners often face financial difficulties if their exploration efforts are unsuccessful. The day-to-day price of gold doesn’t matter as much for these companies as their mining operations, although a prolonged downturn in gold prices could limit their profitability. Individual gold mining stocks carry significant risks. If a gold miner has poor results, its stock price will likely plummet regardless of whether the spot price of gold rises or falls.
Mining companies are often looking for more than just gold. For example, Harmony Gold Mining Company (NYSE: HMY) looks for gold, silver, uranium, and copper from mining operations in the Witwatersrand Basin in South Africa, as well as locations in Papua New Guinea and Australia.
Gold ETFs and Mutual Funds
If owning physical gold sounds like too much of a hassle, let an investment company do the work for you. Exchange-traded funds (ETFs) and mutual funds can be used to gain exposure to gold directly from your brokerage account. And since you own securities and not physical gold, you’ll benefit from the typical capital gains rate, not the collectible rate.
Gold ETFs and mutual funds are structured in different ways. The SDPR Gold Shares ETF (NYSE: GLD) seeks to match the spot price of gold by holding bullion in a vault and creating shares based on its gold holdings. ETFs that hold physical gold charge high expense rates to cover costs, but a 40 basis point expense rate is far more manageable than a 28% collectible tax rate. Other funds that hold physical gold bullion include the iShares Gold Trust ETF (NYSE: IAU) and the Van Eck Merk Gold Trust ETF (NYSE: OUNZ).
Some ETFs use a portfolio of gold stocks to gain indirect exposure to the asset. Note that these ETFs might have vastly different performances from the gold spot price due to the fundamentals of the companies in the portfolio. For example, the Van Eck Gold Miners ETF (NYSE: GDX) holds a portfolio of gold mining companies that depend on finding gold deposits. If the gold miners in the portfolio have a bad haul, the price of the GDX could decline even if the spot price of gold is accelerating upward.
Gold Futures
Derivatives like futures contracts can also add exposure to gold, but these instruments are complex and should only be used by experienced investors. Gold futures investors must project not only where the commodity's price is going but also how long it will take to get there.
A typical gold futures contract has an expiration date, much like a stock option, but no strike price. These contracts usually represent an ownership claim of 100 troy ounces, however smaller amounts are available. The agreement calls for the delivery of physical gold at expiration, although most investors settle futures in cash before delivery.
If you expect the price of gold to rise, you might buy the August 2024 gold futures contract that trades around $2342 (as of June 28, 2024). If the price of gold jumps to $2500 by August, you can sell the contract for a profit or take delivery of the 100 troy ounces at the lower price. However, futures trading involves plenty of risk. Commodities trade 24 hours per day during the week, and volatility is frequently high. Futures trading also involves margin, which means you could lose more than your original investment amount.
Benefits and Risks of Investing in Gold
Some of the benefits of adding gold to your portfolio include:
- Diversification: Gold is a commodity that often does well in turbulent periods, and its price movements tend to be uncorrelated with the overall stock market. A portfolio with a diverse asset base can help protect your capital across bull and bear markets.
- Protection Against Inflation: In periods of high inflation, gold can preserve purchasing power better than cash and help investors maintain their wealth.
- Long-term Value Retention: Gold has been a valuable commodity for thousands of years and will likely continue to be so. Unlike a stock that can see its underlying company go out of business, owning gold is considered a safe way to preserve capital over time.
Investing in gold has downsides as well, so consider the following risks when adding gold exposure to your portfolio:
- Volatile Price Swings: Like any commodity, precious metals like gold are subject to market volatility. Gold might be considered a safe haven, but that doesn’t mean it can't have whipsaw price action.
- Expenses: Physical gold requires storage, which can be costly, and is also subject to high taxation due to its status as a collectible in the eyes of the IRS.
- Potential Underperformance: Gold is often considered a safety play, but if the market or economy doesn’t roll over, gold could be left in the dust by the performance of other assets like stocks.
Are Gold Stocks Worth Buying?
Whether or not gold is a worthwhile investment for your portfolio depends on your goals, risk tolerance, and investment timeframe. Like any commodity, gold can be volatile and taxed differently depending on how you own it. Owners of gold bullion face storage costs and high taxes, while investors in gold stocks and ETFs face individual company and issuer risk.
If you want to preserve wealth in times of economic trouble, gold has long been a steady asset, especially when the threat of inflation is looming. Gold prices often rise during inflationary spells as investors seek to preserve purchasing power while taking money from riskier ventures like stocks. Gold bullion, stocks, and futures offer three unique avenues for exposure, but you must understand the risks of each asset, as well as the overall market risk. Like any company or stock sector, gold has a place in a portfolio but should never be the only asset.
How to Start Investing in Gold
Thanks to assets like gold ETFs and mutual funds, you can get started with gold investing as quickly as you can open your brokerage app and purchase shares. Gold miner stocks and futures contracts can also be purchased on an exchange through a brokerage account.
Owning physical gold is a little more complicated. You’ll need to purchase assets like bullion or jewelry from reputable sources and store them safely. Physical gold is also taxed at a higher rate than assets like stocks or futures contracts, so always consult your investment plan or an advisor when adding a new asset class to your portfolio.
Gold is One of the Oldest and Safest Assets, But Is Not Without Risk
Gold is a unique investment asset. It has been desirable for thousands of years and has many practical uses beyond just shiny coins and pretty jewelry. And, unlike our investment ancestors, gold can be added to your portfolio today as easily as buying a stock or contracts on a futures exchange.
However, while gold is often considered a safe haven during economic turbulence, it's not without risk. Just like other asset classes, gold prices can have volatile moves, and predicting bear markets and recessions is hard. Gold may lag other asset classes like stocks during bull markets, and owning bullion is especially onerous from a tax perspective. Safe doesn’t mean risk-free, so consider talking with an advisor before adding gold to your holdings.
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