Are you looking to include gold in your portfolio? Learn about the different alternatives and their pros and cons.
Gold. It’s the yellow metal, the “barbarous relic,” but it’s also a medium of exchange that’s been respected as a store of value since ancient Egypt, and an asset class that some investors might consider as part of a diversified portfolio.
But when it comes to investing in gold, there are many approaches, from direct purchase to investing in the companies that mine and produce the precious metal.
Gold has an emotional attachment that can make it different from other investments. When we exchange wedding vows, we do it along with the exchange of golden rings. In school we learned of the “49ers” who flocked to the West Coast during the California Gold Rush. And we’ve all heard the radio pitch telling us that empires were built on gold and how, on a long enough timeline (or after the zombie apocalypse), gold will replace fiat currency as the chief unit of exchange.
Some advisors recommend gold as a way to add diversification to a traditional portfolio of stocks and bonds. Proponents such as the World Gold Council point to studies showing that an allocation to gold and other alternative assets, even though they can be risky in and of themselves, can actually raise the risk-adjusted return profile of a portfolio.
Why? One answer is gold’s low correlation to traditional assets, which proponents say can act as a hedge against systemic risk, especially during periods of stress in the stock and bond markets. Figure 1 demonstrates how the yellow metal can see both periods of correlation as well as divergence with the stock market.
But diversification alone shouldn’t be the basis for adding gold as an investment. Plus, there’s no guarantee that diversification will eliminate the risk of loss.
Bottom line: If you’re considering adding gold to your portfolio, you should look at it with the same care and consideration you give any of your financial decisions. And with that in mind, let’s take a look at some of the choices available for investing in gold. We’ll start where the ancient Egyptians did—with the physical metal.
Traditionally, ownership of the physical product—gold coins and bars—is the most common and straightforward way to invest in gold. Simply buy coins or bars from an online dealer, or from your local coin shop, and then put them away for safekeeping. But buying the physical metal is also the most inefficient way to own gold.
Markups and commissions on physical gold sales can be high, and depending on where you live, you may have to pay sales tax on the purchase as well. Uncle Sam collects when you go to sell your gold, too. The IRS considers gold bullion and coins “collectibles,” which are subject to federal taxes at your regular tax rate up to a maximum of 28%.
The storage of physical gold is also a problem. Are you willing to keep your gold at your home, where it may be at risk of theft, fire, or natural disasters? Some companies will offer to store your gold for you, and you can always get a safe-deposit box at the bank, but in both scenarios you’ll be charged a fee and may not be able to access your gold if you need to sell it on short notice.
If you’re considering adding some of that glittery yellow metal to your portfolio, but you’re not sure where to start, consider using screeners. Here are two ways.
Gold mining companies come in two different sizes: junior and major. Junior miners are companies that are newer or more speculative, often mining unproven claims and hoping to find a big score. Major miners are more established companies with production and infrastructure in place, mining on proven and sustainable claims. Both categories include a number of publicly held companies.
The theory behind buying mining stocks is that, as the price of gold goes up, the profit margins of the companies go up as well, which may be reflected in their stock prices. But the price of gold is only one component of the underlying value of these companies. Factors such as geopolitics, the cost of energy and labor, and even corporate governance can impact the profitability of individual mining firms but not necessarily the price of gold. As with any investment, it’s important to do your research before investing.
Exchange-traded products (ETPs) such as a gold exchange-traded fund (ETF) or exchange-traded note (ETN) can offer exposure to the precious metal, but not all ETPs are alike. Some involve physical ownership of the metal, while others use futures, options, and other investments to attempt to mirror the investment profile of owning gold. For TD Ameritrade clients, there are several ETFs offering gold exposure among its list of 550+ commission-free ETFs.
Before investing in an ETF, be sure to carefully consider the fund’s objectives, risks, charges, and expenses. For a prospectus containing this and other important information, contact us at 888-669-3900. Please read the prospectus carefully before investing.
ETNs are not funds and are not registered investment companies. ETNs are not secured debt and most do not provide principal protection. ETNs involve credit risk. The repayment of the principal, any interest, and the payment of any returns at maturity or upon redemption depend on the issuer’s ability to pay. The market value of an ETN may be impacted if the issuer’s credit rating is downgraded. ETNs may be subject to specific sector or industry risks. Leveraged and inverse ETNs are subject to substantial volatility risk and other unique risks that should be understood before investing. ETNs containing components traded in foreign currencies are subject to foreign exchange risk. ETNs may have call features that allow the issuer to call the ETN. A call right by an issuer may adversely affect the value of the notes.
When investing in gold via futures or options, you’re using leverage to control a larger amount of the commodity than you could with just the money you’re putting at risk. This can be an efficient way to participate in gold price fluctuations—up or down—depending on whether you’re bullish or bearish on the market.
Gold futures typically respond to stock market volatility, and some investors often migrate to them as a hedge when stocks fall. But remember, it’s important to know there are different characteristics associated with the pricing of futures and options. Plus, leverage works both ways. It can turn a small amount of money into a large gain, but the reverse is also true—your losses are magnified as well.
Ultimately, if you’re looking to add gold to your portfolio, consider which products make sense and feel most comfortable for you. And let’s hope that zombie apocalypse never comes.
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