Gold has been a symbol of wealth and security for millennia, but it’s not something most investors consider when building a portfolio. Today’s gold bugs are usually the conspiracy theorists of the financial community and the price of the precious metal hasn’t made an inflation-adjusted, all-time high in nearly 40 years.
But lately gold has been making a comeback.
Global tensions are beginning to ratchet up and investors have been giving gold another look. Since owning physical gold is too much of a burden for most people, exchange-traded funds (ETFs) have become the preferred choice for exposure to the world’s shiniest commodity.
Quick Look: The Best Gold ETFs to Watch Out for
- SPDR Gold Trust (GLD)
- Aberdeen Standard Physical Swiss Gold Shares (SGOL)
- iShares MSCI Global Gold Miners ETF (RING)
What are Gold ETFs?
Gold ETFs are actually a combination of 3 different products: closed-end funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs):
Closed-end funds (CEFs): CEFs work much the same way as ETFs, but with a few pertinent differences. CEFs are managed by advisors and must be registered with the SEC. CEFs raised money through an initial public offering (IPO), but after that initial capital influx, the fund closes its doors to new buyers. The net asset value (NAV) of a CEF is calculated regularly, unlike mutual funds that calculate NAV only once at the end of the trading day.
Exchange-traded funds (ETFs): An exchange-traded fund is an investment fund traded on stock exchanges like a stock. An ETF can be made up of assets such as stocks, commodities or bonds.
Exchange-traded notes (ETNs): ETNs are more like bonds than stocks, although they pay no interest. ETNs are unsecured debt products that track an underlying index such as the spot price of gold. ETNs are highly susceptible to tracking error risk and liquidity risk.
History of Gold ETFs
Gold trading has existed for thousands of years, but the trading markets have changed while the precious metal has stayed the same. Money is printed on paper and most financial transactions are done online and leaves physical gold as an archaic medium. Moving and storing bullion costs money and the product quality has a wide range.
The desire for gold still existed in the wake of the dot-com bubble and many traders wanted a vehicle to access bullion more efficiently. True, the image of NYSE traders throwing bricks of gold to each other across the trading floor is enjoyable, but a more practical solution was needed to bring gold trading to the exchange floor.
Enter State Street Global Advisors. It launched the SPDR Gold Trust (GLD) as an ETF in 2004 and gave investors access to physical gold without the need to move it, store it or pay insurance on it. The SPDR Gold Trust tracks the spot price of gold using physical gold bullion stored in a London vault.
GLD gave investors 2 advantages that owning bullion did not:
- Investors no longer had to access physical gold themselves to gain exposure to the precious metal.
- Investors could now buy and sell gold investments on exchanges, greatly enhancing liquidity and decreasing transaction costs.
Gold ETFs took off as investors could finally benefit from the metal without expensive storage and transaction costs.
Today, dozens of gold ETFs and related products are available at brokerages worldwide. Vehicles like ETFs typically invest in either physical gold bullion or the shares of companies that mine, produce and sell gold. This may not sound like a huge difference, but the IRS sees things quite differently.
ETFs that base their share price on the direct ownership of gold do not get favorable tax treatment. Since physical gold is considered a collectible, gold ETFs that invest in physical bullion are taxed at that level. Instead of the usual 20% long-term capital gains rate, shares of ETFs like GLD are taxed at the collectible level — long-term can be as high as 28%.
You can also consider buying ETFs that invest in physical gold in an investment account like a Roth IRA. Since Roth IRA funds are taxed at deposit, any gains from the price of gold won’t be taxed at the collectible rate.
Consider one of these ETFs if you want gold exposure in your portfolio:
- SPDR Gold Trust (GLD): Of course the largest gold ETF is a SPDR. The SPDR Gold Trust has over $40 billion in assets and uses gold bars from England to track the spot price. The expense ratio is 0.40% but the IRS considers GLD a collectible, so prepare for a bill.
- Aberdeen Standard Physical Swiss Gold Shares (SGOL): This fund might be a mouthful, but the expense ratio is a miniscule 0.17% and it still carries over 1 billion in assets. Gold spot price is tracked using bars stored in Germany for SGOL, so again, the IRS will want a large cut.
- iShares MSCI Global Gold Miners ETF (RING): Instead of holding physical gold, RING invests in gold stocks like Barrick Gold and Newmont Goldcorp. Expense ratio is 0.39% but investors are taxed at the normal capital gains rate.
Future Outlook for Gold ETFs
Gold continues to be a popular hedge against the world’s problems, whether it be inflation, political risk, currency fluctuations or trade wars. Of course, gold is by no means a perfect hedge against anything. Just because stock prices go down doesn’t mean that gold prices will go up. As always, it’s important to do your research and make investments that align with your long-term goals.
That being said, here are a few pros and cons to owning gold ETFs.
Why You Might Want to Buy It
Here are some reasons you may consider adding gold ETFs to your portfolio.
- More efficient than physical gold: Buying gold bullion means interacting with dealers as well as paying transactions costs, storage and the appraisal. Owning and storing physical gold is far more impractical than buying a security on the NYSE. Gold ETF owners can reap the benefits of gold ownership without the hassles.
- Diversification from stocks and bonds: It’s difficult to find true diversity in the stock market, even if you invest in countries and industries all over the world. Stocks tend to all move in the same direction, and so do bonds. If you want an asset that isn’t correlated with the typical market forces, gold is a great way to balance that risk.
- Hedge against uncertainty: Does today’s uncertainty worry you? Then investing in gold might provide the safety and security you’re looking for. Gold prices tend to increase when the world goes mad and investors flock to safe haven assets.
Considerations Before You Buy
Make sure to take these points into consideration before making your purchase.
- Heavy tax burden: You’ll be taxed at the collectible rate if you buy gold ETFs that invest in physical bullion, not the capital gains rate. This means paying 28% on your gains for some investors.
- Not a perfect hedge: Is gold really a hedge against uncertainty? Sure, but not always. Gold prices have declined during periods of uncertainty, like in the early 1980s.
- High expense ratios: Compared to broader stock market ETFs, gold products are expensive. Fidelity, Vanguard and Schwab have stock ETFs with expensive ratios near 0%, the cheapest gold ETFs still charge expense ratios up to 0.25%.
How You Can Buy Gold ETFs Right Now
Want to add gold to your portfolio? Make sure you measure the pros and cons of owning a precious metal and think about where gold fits into your investment profile.
Step 1: Allocate a Portion of Your Portfolio for Gold
How much of your portfolio should be devoted to gold? Not much. Since gold is a hedge against uncertainty, you probably don’t need it that often. Keep your allocation small, especially when stocks have been strong. Consider owning them in a Roth IRA to avoid the collectible tax if you plan on buying ETFs that own physical gold.
Step 2: Decide on Which Gold ETFs to Purchase
Gold ETFs are not created equal. Some ETFs track the spot price of gold using bullion; others buy shares of gold mining companies. And yes, some are triple-leveraged ETNs focusing on junior gold miners. Make sure you buy liquid, low-cost ETFs like GLD or SGOL.
Step 3: Find a Low-Cost Online Brokerage
Once you’ve determined which gold ETFs to add to your portfolio, you’ll need to find a broker. Choose a broker with low commissions — you’re buying gold ETFs to keep transaction costs down, remember? Most legacy brokers have dropped their trading commissions to $5 or less. Plus, online-only brokers like Robinhood and WeBill offer completely commission-free trading. You’re paying too much if you pay more than $5 per trade.
Step 4: Find a Suitable Entry Point
Now put your trader hat back on. Since we’re buying gold ETFs on an exchange, you’ll need to find a good entry point just like any stock trade. Don’t just dive right in with a market order at the opening bell. Look for a support level where you’d feel comfortable opening a position.
Step 5: Execute Your Trade
Locate a support level and open your position using a limit order. Limit orders enter your trade only once a specific price has been reached. Your trade will automatically fill at the best possible price — one much different than you anticipated. Once you execute your trade, track your investment and keep your portfolio properly balanced.
Find a Place for Gold in Your Portfolio
Gold has long been the forgotten stepchild of financial assets, but ETFs allow investors to gain exposure to precious metals without the need for moving and storing bullion. Gold ETFs come in several different forms and invest in either physical bullion or gold mining companies.
Owning gold might protect your portfolio from global uncertainty and provide diversification from the stock market, but there’s no guarantee stocks and gold will move in opposite directions.
Gold ETFs that own bullion also have different tax implications to consider. Purchasing an asset like this requires a lot of deliberation.