How to Invest in Gold

Benefits and Risks of Investing in this Precious Metal

How to Invest in Gold
December 18, 2013

Gold has been the go-to commodity as a hedge against inflation and global political and economic volatility. A key diversification tool, advisors recommend investing anywhere from two to upwards of 20 or even 30 percent of your total portfolio in the precious metal. Most investors generally hover in the two to five percent range for investing in commodities — not just gold, but a diversified mix of precious metals, oil and agriculture. When stocks and other markets are in crisis, gold tends to rise in value, offsetting other poor-performing areas of your portfolio. The growing demand for gold from emerging markets, limited supply and the increased costs associated with mining the metal all point to gold as a solid, long-term investment.

From bullion and stocks to exchange-traded funds (ETFs) and notes (ETNs), there are many approaches for investing in this commodity. Gold rises and falls by the hour and has fluctuated in value by more than 10 percent in a given year. So although the long-term reputation of gold continues to be fairly solid, investors should be prepared to accept this level of volatility as a normal characteristic. Today, the most common ways to invest in gold include buying gold bullion (bars, ingots, or coins), futures, stocks or ETFs.

Before you rush out and buy a bunch of bullion, you should first research transaction fees, plus storage and insurance costs. You should also think about purchasing your bullion in convenient sizes for quick liquidation down the road. Another consideration before buying bullion: there are no dividends derived from this physical asset. However, the appeal of gold is that it is easy to liquidate and your initial investment can be as low as roughly $500 for a single ½ ounce coin. The markup decreases significantly when you buy in larger volumes, typically 20 ounces or more. If you do decide to go the physical route, be sure to purchase in full ounce increments for lower markups, and go with coins that are government-backed, such as the American Eagle Gold, American Gold Buffaloes, South African Krugerrand, or the Canadian Maple Leaf Gold.

Gold futures contracts (legally binding agreements for delivery of gold in the future at a set price) are bought and sold on several exchanges, and many gold mining companies sell shares of stock. But gold stocks are more volatile than futures, and they don't necessarily correlate directly to the current value of gold, because you are investing in a company, its management and corporate practices, not just the metal. Exchange-traded notes (ETNs), based upon the performance of a market index minus applicable fees, are yet another option, but because they do not have any principal protection, there is the risk of losing everything you invest.

Gold ETFs, which are tracked on COMEX, (Commodity Exchange, Inc.) a division of the New York Mercantile Exchange (NYMEX), include SPDR Gold Shares (GLD), iShares Comex Gold Trust (IAU) and ETFS Gold Trust (SGOL), track the spot price of gold. ETFs offer a simple, affordable alternative to owning, storing and insuring bars or coins, while retaining the protective properties the metal has in terms of insuring your portfolio against risks inherent to other markets. With these ETFs, you don’t physically own gold and your shares can only be traded in for cash. From a tax perspective, if you own shares of ETFs for more than a year, it is as though you own the precious metal and capital gains taxes come into play. To avoid this scenario, your best bet is to have your tax-sheltered IRA hold ETFs.

Whichever option you choose, you will have some flexibility. For instance, companies that sell gold bullion or coins, such as Blanchard and Company, transfer ETFs into physical gold. And Sprott Physical Gold Trust ETV (PHYS), a close-ended mutual fund, allows investors to trade in shares for bars of gold. Read the fine print and be sure to gain a full understanding of key influences for each type of investment, as well as the tax implications that accompany each approach. Depending on your investment goals, your comfort level with the intrinsic volatility of precious metals and risks of each investment approach, having a solid understanding of such advantages and disadvantages of physical versus paper investment options when it comes to gold will help you protect your portfolio from both predictable and unexpected economic and political scenarios.

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