Different Ways To Expose Your Portfolio To Gold and When It Makes Sense To Invest In It
Today, there are many different ways to invest in gold, from buying physical gold coins and bars to investing in gold-backed exchange-traded funds (ETFs) and stocks. However, before you decide how to invest, you have to decide if you should invest in gold. So is investing in gold a good way to diversify your portfolio and protect it against market volatility? Let's take a look.
The Basics of Investing in Gold
About 10.8% of Americans own gold as an investment. Investing in gold is much more than owning a wedding ring or other piece of gold jewelry. It's holding gold or a related asset as part of your overall investment portfolio.
Traditionally, investors bought bullion in bars or coins. Bars range in size from 1 gram up to 1 kilo or a bar about the size of an iPhone. Gold coins can come in various sizes and denominations depending on their country of origin. When considering physical gold, it can be important to consider any additional costs associated with storage, insurance, and transaction fees.
Another way to invest is through gold company stocks. Gold stocks are shares of companies that extract or trade in gold or other precious metals. Investing in gold company stocks might allow you to take advantage of the returns of gold without having to purchase physical gold. However, investing in gold stocks does carry some additional risks. Like other individual stocks, you’re investing in the company, and the value of its shares is based on the company’s performance and the price of gold.
You can also buy gold futures or invest in gold funds (such as a mutual fund or ETF). To trade in futures, you need a brokerage account and a solid understanding of the way futures prices and time expectations work. In short, you buy a contract that allows you, for a certain period of time, to buy or sell an asset at a specific price. You are not obligated to buy or sell, but you have the option. Buying gold funds simply means buying a fund with exposure to gold or that aims to replicate the price of the commodity. Some funds invest solely in gold bullion, while others will invest in a combination of bullion and gold companies.
Some scam artists will try to sell so-called "gold certificates" or other forms of "paper gold" as an alternative to physical gold. While these products may sound legitimate, they were actually outlawed in the U.S. in 1933.
Why is gold valuable, and how is it taxed?
Despite its glitter, gold does not hold any intrinsic value of its own. Gold's value is largely determined by a complex interplay between central banks, currency values, jewelry demand, gold production, and global economic conditions. It’s worth what someone else is willing to pay for it.
The taxation of gold depends on what type of investment you make and whether you are holding the physical metal, a gold fund, or some other form representation of it.
For example, if you buy gold investment stocks or funds, any gains you make may be subject to capital gains taxes. On the other hand, if you purchase physical gold, such as coins or bullion, the IRS generally considers your investment to be a collectible and taxes it as if it were art or antiques.
Does Investing in Gold Have a Future?
The value of gold has been used as an investment throughout history, but it wasn't until the 1970s that Americans could actually invest in gold. During the late ’70s, investors saw gold prices rise by drastically. Meanwhile, the stock market gyrated up and down throughout the decade with no real wins.
At that time, gold's future looked bright. Things changed, however, when gold prices peaked in 1980. As the overall economy improved, gold prices fell from $875 an ounce in January of 1980 ($2,318.84 in today's value) to $317 in 1985 - a 64% drop. Gold continued to underperform against other investments until the early 2000s when economic turbulence caused some investors to run to gold.
This history raises the question: Does investing in gold have a future?
The answer is it depends on who you ask. For some, gold is still regarded as a safe haven asset, which means that when the stock market experiences periods of great loss, gold may remain relatively stable. Historically, when the market has gone down, gold prices have not always followed suit. During the 2008 financial crisis, we saw gold prices initially increase as stocks prices declined. It’s important to note, however, this is not always the case. In 2022, we saw both gold and stock prices drop; however, gold fared much better than stocks.
When looking at longer periods of time, gold has not always kept up with stocks. As gold has yet to reach its August 2020 all-time high. While stocks, in general, hit new highs throughout 2021 and, as of the end of the year 2022, remain well above pre-COVID prices.
As with any other investment, gold can play a role in your investment strategy, but it might not be the right investment for everyone.
Is Gold a Good Investment During Inflation?
Conventional wisdom says that when inflation goes up, so does the price of gold. Consequently, gold tends to be a popular, safe-haven asset when inflation markers rise.
But just because a choice is popular, doesn't mean it's smart. Should you invest in gold during inflationary periods? Let's look at the data.
From 1973 to 1979, U.S. inflation averaged 8.8% per year. During the same period, gold returned an annualized average of 35%. From 1980 to 1984 saw a rapid reversal of this trend with inflation averaging 6.5% and gold falling by 10% in value each year. After that, inflation trends stayed low and so did gold's return.
Post-COVID, economic realities shifted again and inflation increased at a near-record pace. Gold, though, did not follow suit. Instead, it has added value more slowly, growing by roughly 0.5% in 2022.
Historically, the link between inflation and gold does not appear to be as strong as some may have thought. So will gold's returns ramp up in 2023? No one can say for sure what any investment will do in the days to come. That doesn't stop commentators from prognosticating, however.
Some observers believe 2022's lackluster returns occurred because of China's reduced demand, the dollar's bump up in value, and aggressive Federal Reserve rate hikes. While some market watchers believe gold will rise faster in 2023, they may be disappointed if these external factors remain in place.
Like any investment, investors should be aware of the potential risks associated with investing in gold and should make sure they understand how to invest in gold before investing any money.
The Risks of Exposing Your Portfolio to Gold
Some main-street investors believe that gold is a built-in hedge against inflation because they believe it is linked to the U.S. dollar. They are wrong. In 1971, President Richard Nixon signed legislation that severed any remaining link between the U.S. and the gold standard. Furthermore, gold is not used as a legal form of currency anywhere in the world.
Other concerns about investing in gold may include its historically poor returns, increased volatility, lack of utility, and overall inefficiency. Historically, gold has struggled to keep up with or beat market index funds. Unlike other precious metals, gold has very little use in industry. It can also be hard to insure and store, and the world is mining more of it every year. In addition, it doesn’t pay cash dividends the way that some stocks or bonds do.
The only way to make money off of gold investments is if the price of gold increases. This can make it difficult to predict your investment's potential performance. However, gold is not always a poor performer.
The Benefits of Exposing Your Portfolio to Gold
Gold is a hard asset that is not tied to the stock market, currencies, or other securities, so it may help increase diversification and may provide a hedge against the next market uncertainty.
Here are some of the potential benefits of adding gold to your portfolio:
Gold Investment Returns: While gold has vastly underperformed the S&P 500 since 2012, it does generally increase in value. Looking back to the 1920s, gold has outperformed the stock market during some 10-year periods, although never over a 30-year period.
Diversification: Exposing your portfolio to gold can provide additional diversification which may help manage risk. Over time, gold has moved through time differently than traditional stocks and bonds, so adding it to your portfolio could provide some dissimilar price movement.
Inflation or Geopolitical Hedge: Gold could be beneficial in times of economic uncertainty or rising interest rates.
Long-Term Investment: Gold is a long-term investment that might generate steady returns.
How to Invest in Gold in 2023
For some investors, gold may be a sensible asset. If you believe gold is right for you, how do you go about buying some?
Here are three ways to invest in gold in 2023:
Gold Mining Shares or Stock: Buying shares in a gold mining enterprise is one of the most popular ways to invest in gold. The disadvantage of gold company stocks is that they are subject to business and market risk and will rise and fall with the broader markets.
Gold ETFs: Investors can also use gold funds such as gold ETFs to gain exposure to the metal's performance. The advantage of these products is that investors may gain larger returns if gold prices go up but also face greater risks if prices decline.
Physical Gold: Investors can also purchase physical gold by buying gold coins, bars, or even jewelry. The advantage of physical gold is that you can hold it in your hand and don't have to worry about market fluctuations. However, the disadvantage is that you'll have to pay transaction fees and storage fees, which may offset some of your gains.
No matter which method you choose, it's important to understand the risks associated with investing in gold before making a decision. Make sure you research each option thoroughly and weigh the potential risks versus rewards before making an investment decision.
The Bottom Line
Whether or not you should invest in gold usually depends on what you’re trying to accomplish, your other investments, and your overall financial situation. You might find that there is an alternative investment that helps you accomplish your goal. Or that your existing investments already provide the type of diversification and hedge that you seek.
With its low correlation to stocks and other investment returns, gold can provide some form of stability and diversification to an investment portfolio. That said, investors who have a longer time horizon in the market may be better served by sticking with other asset types.
As always, it's best to do your research and consult a financial advisor before making any investments. If you have questions about your investments and whether gold is right for you, contact Cooke Wealth Management. We'd be glad to talk with you.
Disclaimer: All investing and assets involve risk, including the potential loss of money. There is no guarantee that any mix of funds or diversification will meet your goals or protect against a loss.