Investing in Gold: What to Know
Adding gold to your portfolio can help you hedge against inflation and diversify. Learn the benefits and disadvantages here.
Gold has been a powerful symbol of wealth and luxury for thousands of years. Humans have found uses for it in jewelry, architectural adornments, and, of course, as a form of currency. The one constant? It’s remained a source of tangible monetary worth, even in the complex financial environment of the present. As markets go under and other currencies lose value, gold remains.
Today, people turn to gold as a means of diversifying their portfolios. There are several options to accomplish this, including physically storing it and buying shares of ETFs or mutual funds. In this article, we’ll explore how this precious metal works. We’ll detail both the benefits and drawbacks of investing in it, as well as explain typical ways to add it to your portfolio.
Why Invest in Gold?
Investing in gold or the processes related to it, such as mining, has various tangible benefits. This includes its alternative performance to other asset classes, such as equities and fixed-income securities. In some cases, it also helps impede the negative effects inflation or other geopolitical events can inflict on your portfolio. Below, we break down the primary reasons investors add it to their portfolios:
One of the most important reasons people invest in gold or other precious metals, such as silver, is that they provide a layer of diversification. If one security in your portfolio depreciates, it’s important to ensure you have others that can offset those losses. Because commodity investments (i.e., gold, silver, oil, etc.) follow different trajectories than other assets, such as equities or fixed-income investments, they act as an effective way to diversify and, thus, mitigate risk.
Hedge Against Inflation
Investors and financial experts often discuss precious metals as an inflation hedge. When the government mints new currency during inflationary periods, the purchasing power of the dollar decreases. However, because gold is a finite, real-life item, it stays consistently valuable to investors. When demand rises, its overall value goes up. Therefore, when significant inflation occurs, it’s not uncommon for people to buy commodities to make up for the losses they’ve seen with their dollars.
Peace of Mind During Economic Uncertainty
As mentioned, regarding market performance, precious metals are a much different animal than popular securities such as stocks or bonds. Unlike stocks, for example, which gain value from corporations faring well, gold receives value from its scarcity and commercial uses, such as in jewelry and electronics. So, when an economic downturn occurs and affects assets like equities and real estate, gold may maintain its worth or even increase in value, often due to higher demand.
A somewhat recent example occurred just after The Great Recession in 2008. According to the Bureau of Labor Statistics (BLS), gold prices increased by 12.8% in 2009. Then, from 2010 to 2011, prices for the metal surged by 50.6%. The reason for this? While Americans were reeling from the momentous economic crisis, many likely turned to tangible assets such as precious metals, driving up demand and selling prices.
More recently, when the COVID-19 pandemic affected economic markets, investors turned to gold once more. This led to an extreme price increase, much like what happened following the 2008 crisis. Per data from TradingEconomics.com, prices climbed to an all-time high of $2,034.70 per troy ounce on August 3, 2020. Whereas the stock market experienced drastic drops, some investors almost certainly saw commodities as safe securities to which they could allocate their money.
What Are the Disadvantages?
Just as gold carries its advantages, including being a vehicle for diversification and a store of value, it has its disadvantages. One of the main ones is its volatility. Prices often fluctuate due to market conditions and overall demand. So, if you encounter a situation where you need to sell your holdings, but prices have gone down, there’s a chance of losses.
Another issue is that gold doesn’t provide any income or interest. Robert R. Johnson, PhD, CFA, who previously served as the deputy CEO of the CFA Institute and president of The American College of Financial Services, explains, “Gold is a speculative investment, based on the Greater Fool Theory. The price of gold is not determined by its intrinsic value but simply by its expected selling price to someone in the future.” In the end, you’re holding out hope that its value will increase and be at an ideal spot if you ever decide to sell.
Johnson also underlines the problematic quality of gold as a long-term investment. He cautions that “one should never consider investing in gold, particularly if you have a long time horizon, as the long-term returns are far below those of equities.” He continues, “At the end of 1925, the price of an ounce of gold was $20.63. At the end of 2022, an ounce of gold sold for $1,813.75. Over that 97-year period, the precious metal returned 4.72% compounded annually. Over that same time period, according to Ibbotson Associates, the compound annual rate of return of a diversified portfolio of large stocks (the S&P 500) was 10.1%. That same $20.63 would have grown to $1,031,226 at the end of 2020.”
For investors more geared toward putting together a valuable portfolio over time, the former executive and current Professor of Finance at Creighton University recommends “a diversified basket of small stocks,” saying that “[while] having a small position in precious metals may dampen portfolio volatility in the short-run, the tradeoff between slightly dampened volatility and the lost long-term return is certainly not a prudent one, particularly for Gen Z/millennials with long investing time horizons.”
Ways to Invest in Gold
Shiny bars and ingots often float to the top of our minds when we think of gold as an investment. But, while this is one way you can add the metal to your repertoire, there are several different ways to go about it:
Buying physical bullion is the most direct and tangible way to own gold. This includes anything from coins to the large bars you’d see at Fort Knox. By doing this, you own the metal and can hold onto it as its value hopefully appreciates over time. It’s as simple as storing it in a secure location and waiting until the opportune moment arises to sell some of it for a profit.
Storing gold, however, isn’t necessarily an easy proposition. For as long as you possess it, one of your main priorities will be safeguarding it and its immense value. Since there’s always a risk of theft, you’ll need to consider where it has the most protection. You could keep it at home with you in a safe or a hidden location. You could also haul it to the bank and place it in a safe deposit box.
Common sources people use to acquire bullion are:
- JM Bullion
- The American Precious Metals Exchange (APMEX)
- SD Bullion
- Money Metals Exchange
- Golden Eagle Coins
ETFs and Mutual Funds
Instead of buying it physically, another method is investing in mutual and exchange-traded funds (ETFs). These are actively managed funds that specialize in bullion or mining investments. Popular mutual funds include Tocqueville Gold (TGLDX) and the Gabelli Gold Fund (GOLDX). Some common ETFs are the iShares Gold Trust (IAU), the Goldman Sachs Physical Gold ETF (AAAU), and the Abdrn Physical Precious Metals Basket Shares ETF (GLTR).
By adding these to your portfolio, you can indirectly own shares of gold without the potential headaches of storing it and keeping it safe. It’s also easier to sell your shares than if you had bullion in a safe somewhere. There’s no need to hunt for a buyer. But if you prefer to move on from the metal, you just need to sell your shares in the fund.
Since these funds are often run by professional managers, you’re likely to pay an annual expense ratio fee. And, while you don’t directly own the metal, there’s still a chance of the market prices going down and lowering the value of your shares.
Gold Mining Stocks
Another indirect way to insert yourself in the gold industry is by buying shares in mining companies. The main advantage of this is that, as prices become more lucrative, the value of your equity in these corporations may increase with it. And, when you invest in the physical commodity and certain mutual funds, you’re reliant on the spot price (the going rate per ounce). On the other hand, the stock you own in mining businesses could become more valuable beyond just the spot price.
Keep in mind, though, that stocks are never a sure thing. Ultimately, you’re depending on the company staying profitable. A litany of risks could impact the value of your investment, including operational problems, decreased gold prices, and unforeseen market conditions.
Futures are another method of adding the valuable commodity to your portfolio. This is where you sign a contract to either buy or sell a specific amount at an agreed-upon price at a future date. In these agreements, you don’t physically own any of the gold. What you’re trading, rather, is the contract itself.
These investments are typically very speculative, as you’re locking yourself in to buy at a certain price with the hope that it will eventually go up. The same is true if your future contract is to sell it. The idea is that you’ll have agreed to sell it for a higher price than it will be later. Of course, with speculation, comes the very real possibility that you could lose out. Gold prices could shift against your expectations, which could lead to losses.
Frequently Asked Questions
What impacts gold prices?
As with any investment, various factors can affect the price of precious metals. Two common ones are:
- Supply and demand. Gold’s rarity is a major factor. As it becomes more in demand and harder to find, its price will rise.
- Geopolitical events. Outside events, such as global pandemics, economic downturns, and wars, can cause costs to go up. This often happens when investors lose trust in governmental structures such as fiat currencies.
What is the smartest way to invest in gold?
This can vary. Some may claim that it’s better to own physical bullion and keep it within your possession. For many, though, it makes sense to own shares of a mutual fund or ETF. This is because it allows you to get the diversification of owning it without worrying about storage or finding someone to buy it for the right price in the future. To find out the ideal investing strategy for you, we recommend talking to a financial advisor. This free matching tool can help you find up to three vetted financial professionals in your area.
What is the safest way to store physical gold?
One of the safest places to hold gold bullion is in a safe deposit box at a bank. This gives it better protection from falling into the wrong hands. You can, of course, also keep it at home. But you’ll want to ensure it’s under lock and key in a spot only you or other trusted individuals know about.
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