Adding gold funds to your portfolio can be a way to diversify, or it can create a hedging strategy. Gold can be used as a hedge against (or as a safe harbor from) inflation, stock market declines, or falling currency prices—especially with the U.S. dollar.
Gold has been used as a currency for many years. It's remained valuable throughout history. Different methods of investing in gold can result in a nice profit. There are gold hedge funds, exchange-traded funds, gold-backed securities, gold mining stocks, gold mutual funds, and gold futures options to choose from.
Investing in Gold Mutual Funds and ETFs
You don't invest directly in gold itself when you invest in gold funds. The most common means of buying gold directly is in bullion gold coin. The most common way to invest in gold as an investment security is through an exchange-traded fund (ETF), such as the SPDR Gold Shares (GLD).
Mutual funds invest little to no assets in physical gold. They often hold the stocks of mining companies.
Gold Mutual Funds or Gold ETFs?
You can invest in ETFs that are exposed to gold, such as bullion or by trading in gold futures, if you want to invest in a manner that tracks its prices. Gold mutual funds often invest in the companies that mine gold. One difference between these two types of funds is that the mutual fund will move with the market and the value of the company, while the ETF will move with the value of gold.
One ETF may have fewer fees than another, and the same could be said of a mutual fund.
The traits of both these options lead to choosing the one that is right for your portfolio and your investing goals. One option might be to use the ETF as a hedge against inflation, a market decline, or decline in value of mining company stocks because gold prices are often steadier than stock prices.
Gold as a Hedge Strategy
Investors have had concerns about the devaluation of the U.S. dollar. The federal government pumps more money into the economy to stimulate it due to large deficits. But the more currency that is in circulation, the lower its value. More investors put money in gold as a perceived safer alternative when concerns over dollar value increase.
Hedging is the term used for mitigating the risk of losing money. A hedging strategy is a plan an investor has to lessen the impact of losses.
As the demand for gold increases, so does its value, which in turn raises its price. Gold is thought to be a safe haven for related reasons. Investors feel safer with real assets in times of economic uncertainty. Gold can be used as a hedge against inflation, and as a hedge against hard economic times.
The Advantages of Investing in Gold
The basic advantages of investing in gold derive from it being a fixed asset. There's a strong global demand for gold. As such, its price moves up and down in the short term, but it often rises in value over the long term, although without a similarity to stock prices. Gold is often thought to be a steady value investment.
It's a very liquid asset. You can readily convert it to cash or to other investments if needed. Investors tend to run to precious metals when there's an investing crisis because gold often retains its value during these times. Gold has become a diversification strategy for many investors for this reason.
The Bottom Line
In the end, it comes down to what you need and want for your portfolio. You could set a percentage of gold funds if you need to hedge some risk against falling stock prices. You could invest in physical assets if you want to hedge against a failing economy. Your tolerance for risk should guide you in your choice. It wouldn't hurt to have both.
Gold should never be used as a timing tool, or as the sole vehicle for all your savings. The price of gold can take dramatic turns. The long-term average return for gold as an investment trends around 3%. This is much less than that of most S&P 500 stock funds. A good gold fund allocation for most investors is around 5%.
Frequently Asked Questions (FAQs)
Which is better, physical gold or gold mutual funds and ETFs?
There are advantages and disadvantages to investing directly in physical gold. Some investors prefer the security of physically holding their gold investments and storing them in a safe place that they can access anytime. However, physical gold is much harder to trade, and you'll pay higher fees. Gold funds allow investors to jump in and out of gold investments with the click of a button and minimal fees.
What determines when gold mutual funds rise?
Gold prices are subject to supply and demand. On the demand side, prices will rise as more investors feel the need to hedge with gold. On the supply side, mining can help put pressure on gold prices.