How to Invest in Gold Funds & ETFs

Strategies for Investing in Gold Mutual Funds and ETFs

gold coins
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Adding gold funds to a portfolio can be a method of diversification or of creating 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 US dollar.

Gold has been used as a currency for millennia, remaining valuable throughout recorded history. In modern times, gold has become an instrument used to create more wealth, via investing, rather than as a method of physically accumulating wealth. There are different methods of investing in gold that can be very profitable.

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

When investing in gold funds, you generally don't invest in the commodity itself directly. The most common means of buying gold directly is in bullion gold coins; the most common way to invest in physical gold indirectly (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. Usually categorized as "Precious Metals," gold mutual funds typically hold stocks of mining companies. A few of the best gold mutual funds, in terms of long-term performance, long manager tenure and average to low expense ratios include Sprott Gold Equity Fund (SGDIX) (formerly Tocqueville Gold (TGLDX) and Gabelli Gold Fund Class AAA (GOLDX).

Gold Mutual Funds or Gold ETFs?

If you want to invest in a manner that tracks the prices of gold, you can invest in ETFs that are exposed to physical gold, such as bullion or by trading in gold futures. Gold mutual funds typically invest in the companies that mine gold. One difference between these two fund types is that one will fluctuate with the market and value of the company (the mutual fund), while the other (the ETF) will do so with the value of the commodity.

Both ETF shares and mutual fund shares are taxed as capital gains if you sell your shares.

Both gold ETFs and mutual funds may differ in their fees. One ETF may have fewer fees than another, while the same could be said of a mutual fund. For example, the mutual fund Fidelity Select Gold Portfolio (FSAGX) charges .54% of your total annual investment in management fees, whereas Invesco Oppenheimer Gold & Special Minerals Fund Class A (OPGSX) charges .68% of your total investment. 

Fees for ETFs are similar. Vaneck Vectors Gold Miners ETF charges a management fee of .5%, while SPDR Gold Shares charges a reoccurring fee of .4% of the holdings net asset value. 

The traits of both of these investment options lead to choosing the one that is right for your portfolio and 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 since gold prices generally are more steady than stock prices.

Investing in Gold as a Hedge Strategy

In recent history, investors have had concerns about the devaluation of the US dollar. Due to large government deficits, the federal government pumps more money into the economy to stimulate it. However, the more currency that is in circulation, the lower its value. As concerns over dollar devaluation increases, more investors invest in gold as a perceived safer alternative.

Hedging is simply the term used for mitigating the risk of losing money. A hedging strategy is a plan an investor has to mitigate losses.

However, the certainty of gold adds to the effect of a self-fulfilling prophecy: as the demand for gold increases, so does it's value—which in turn raises its price. For related reasons, gold is considered a safe haven; investors feel more comfortable with real assets in times of economic uncertainty. Therefore, gold can be used as a hedge against inflation, but also as a hedge against hard economic times.

The Advantage of Investing in Gold

The basic advantages of investing in gold derive from the fact that gold is a fixed asset and that there is strong demand globally for gold. As such, the price fluctuates in the short-term but generally rises in value over the long-term, albeit without similarity to stock prices. Gold is generally considered to be a steady value investment.

Gold is a very liquid asset, which means you can readily convert it to cash or other investments if needed. Investors tend to run to precious metals when there is an investing crisis because gold tends to retain its value during these times. For this reason, gold has become a diversification strategy for many investors as well.

What It All Means

In the end, it comes down to what you need for your portfolio. If you need to hedge some risk against falling stock prices, you could establish a percentage of gold funds in your portfolio. If you want to hedge against a failing economy, you could invest in physical assets. Your tolerance for risk and your investment strategy should guide you in your choice. It wouldn't hurt to have both in a diversified portfolio.

It is important to remember that gold should never be used as a market-timing tool or as the sole vehicle for all of your savings. The price of gold can have dramatic turns and the long-term average return for gold as, an investment, trends around 3.00%, which is significantly less than that of an average S&P 500 stock fund. Gold can be a good diversification tool—an appropriate gold fund allocation for most investor portfolios is around 5%.