What Are Precious Metals?

Stacked gold bars
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DEFINITION
Precious metals are so named because they are rare and thus have a high economic value. Precious metals provide a means for investors to store wealth and seek growth in value.

Precious metals are so named because they are rare and thus have a high economic value. Precious metals provide a means for investors to store wealth and seek growth in value.

The most common types of precious metals that people invest in are gold, silver, and platinum. Other types of precious metals are iridium, osmium, palladium, rhodium, and ruthenium.

Definition and Examples of Precious Metals

Precious metals such as gold and silver have long been used as a means of storing and exchanging value. They also have been used to either mint governmental currencies or to back the value of a government’s currency.

Today, precious metals, which form part of the commodities asset class, mostly are used as a means for investors to diversify their portfolio beyond stocks, bonds, cash, and other holdings, in part because they don’t track the movements of stock or bond markets. 

These metals historically have been a way for investors to seek growth during times of inflation and safety during times of economic uncertainty. Of course, precious metals are also purchased for industrial uses and for commercial purposes, such as making jewelry.

How Investing in Precious Metals Works

There are many ways to purchase precious metals, including purchasing bullion coins or bars. This is frequently done through a financial institution or other third-party broker, although it is possible to buy gold, silver, palladium, and platinum coins directly from the U.S. Mint or other governments’ mints. The cost of turning a precious metal into a coin will likely be added to the price. Also, ownership of precious metals often comes with storage costs (in other words, a safe-deposit box) and insurance costs.

Investors also may gain exposure to precious metals through mutual funds or exchange-traded funds (ETFs). These funds purchase precious metals on behalf of their shareholders, or they invest in the securities of companies involved in the production of gold or other precious metals. There are funds that focus on a single precious metal and funds that invest in a range of them. As with any mutual fund or ETF, there will be fund management fees with precious metals-themed ones.

Another way to invest in precious metals is through futures contracts for a specific metal or the futures contracts of publicly held companies involved in the exploration or production of precious metals. 

A futures contract is an agreement to either buy or sell a publicly traded asset in the future. The contract specifies when the seller will deliver the asset, and what the price will be. Keep in mind that commodity prices are volatile, and futures trading is generally considered a high-risk endeavor that is not for beginning investors—or even many seasoned investors.

Pros and Cons of Investing In Precious Metals

Pros
  • A means of diversifying a portfolio

  • Hold their intrinsic value

  • Hedge against inflation

  • Numerous options for how to invest in them

Cons
  • High taxes

  • No cash flow generated while owned

  • Volatile

  • Extra costs involved, including transaction fees, shipping, storage, and insurance

Pros Explained

  • Diversification: The value of precious metals is not correlated to movements in the stock or bond markets, or the value of real estate.
  • Hold intrinsic value: Their value either remains stable or usually increases over time.
  • Hedge against inflation: Precious metals historically increase in value during times of inflation or economic uncertainty.
  • Numerous ways to invest in precious metals: It’s possible to purchase precious metals directly, to invest in mutual funds or ETFs that own precious metals, to invest directly in companies that mine or manufacture precious metals or to buy into funds that invest in those companies, or to use futures contracts to invest in them.

Cons Explained

  • High taxes: Precious metals are classified as collectibles by the Internal Revenue Service (IRS), which means, in many cases, they are hit with the 28% capital gains tax when sold, instead of the lower tax rates that apply on other long-term investments.
  • No cash flow generated while owned: Stocks can produce passive income through dividends, and real estate can produce passive income through rent received. Even if the value of precious metals increases, they do not produce cash that you can access without selling the asset.
  • Volatility: While the price of gold is relatively stable, the prices of silver, palladium and other precious metals are more volatile, which means losses can occur quickly.
  • Extras costs: If you purchase physical precious metals, they can come with transaction fees, a shipping fee, storage costs, and insurance.

What Precious Metals Mean for Investors

Investing in precious metals is a means of diversifying a portfolio that consists mostly of stocks and bonds. However, an investor should be familiar with the numerous ways to add precious metals to a portfolio, the extra costs that come with these options, and the long-term performance tendencies of the metals or related investments they are considering. Keep in mind also that slow growth or no growth in value can be a risk in and of itself.

Key Takeaways

  • Precious metals, the most commonly traded of which are gold and silver, are assets that tend to hedge against inflation or uncertain economic times.
  • There are numerous ways to add precious metals to a portfolio, including purchasing physical metals (bullion, bricks, or coins), buying mutual funds or ETFs that hold precious metals, or investing in companies that mine or manufacture precious metals.
  • While precious metals tend to hold their value over time, their price can be volatile.
  • It is important to be conscious of extra fees or costs tied to investing in precious metals.

Article Sources

  1. IRS. “Topic No. 409 Capital Gains and Losses.” Accessed Dec. 29, 2021.