Shining a Light on Gold: Weighing the Pros and Cons of Including Gold in Your Investment Portfolio
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Investing in Gold
Investors looking to diversify their portfolios with gold can do so in several ways. They can buy gold bullion, which is physical gold in the shape of gold rounds, coins, and bars, or they can purchase gold-backed assets like stocks, mutual funds, exchange-traded funds (ETFs), futures, or other derivatives.
Owning Physical Gold
Physical gold investments allow you to own the precious metal, giving you full control over it at all times. A gold individual retirement account – or gold IRA – lets you own gold and still enjoy the tax benefits of a conventional IRA.
Gold-Backed Assets
On the other hand, gold-backed assets – such as gold stocks and ETFs – make it possible to invest in gold without having to hold or store it. Sophisticated investors can also trade gold futures and other derivatives, but these are highly complex instruments that can magnify investment losses and aren’t recommended for the average retail investor.
The Pros and Cons of Buying Gold as an Investment
When done properly, an investment in gold can have several benefits. Apart from the fact that buying gold is a fairly simple and straightforward process, the precious metal can be used as a portfolio diversifier, providing a hedge against inflation and offering a safe haven in times of economic uncertainty or geopolitical unrest, all of which serve as price drivers for gold.
The Pros Explained
Portfolio Diversification
Depending on your investment strategy and goals, the precious metals asset class – which includes gold as well as silver, platinum, and palladium – may be a good diversifier for your nest egg. Diversification is an essential part of building a balanced portfolio because it helps protect against stock market volatility while minimizing risk. With the right allocations, having multiple types of assets may help you manage risk and return.
Hedge against Inflation
Gold’s price tends to move inversely to the value of fiat currency, particularly the U.S. dollar. In other words, gold typically rises in value when the dollar weakens.
Safe Haven During Economic Uncertainty
Gold’s resistance to inflation makes it a reliable store of value that preserves wealth over time. That’s why it’s considered a safe-haven asset, particularly during periods of economic uncertainty, geopolitical instability, or a global pandemic.
High Liquidity
Part of building a balanced portfolio is ensuring that it has a decent level of liquidity; that is, making sure that you have access to cash whenever you need it and have the resources to buy better-performing assets when appropriate. Otherwise, an investment opportunity may escape if an asset – such as a high-performing stock – is suddenly available but you don’t have the funds to finance a purchase.
The Cons Explained
Storage and Insurance Fees for Physical Gold
While you’re free to buy and hold physical gold, doing so means incurring storage and insurance expenses since your home may not be the best place to keep it safe. A physical gold investment comes with an ongoing risk of theft, so it’s wise to keep your gold bars and coins in a safer and more protected place, like a bank safe deposit box. The fees to store and insure the precious metal can add up to a large amount and detract from your investment gains.
Capital Gains Tax
You earn capital gains when you sell a dedicated investment, such as gold, at a profit. When that happens, the IRS requires that you pay capital gains tax (with few exceptions, like with a Roth IRA).
Doesn’t Generate Passive Income
Unlike some stocks, ETFs, mutual funds, bonds, and cash alternatives like certificates of deposit, physical gold doesn’t produce yield through dividends or interest. You only get a return on your investment when gold prices rise and you sell. This, combined with the fact that the price of gold rises slowly compared to other asset classes, presents a potential performance lag on your portfolio over time.
Summary of Pros and Cons of Having Gold in Your Portfolio
- While gold can add an element of balance and security to your portfolio through hedging and the creation of liquidity, there are also certain risks of which investors should be aware.
- If you hold your gold bullion in physical form, then you will need to budget for storage and insurance costs.
- Holding physical gold doesn’t generate passive income and is subject to capital gains tax when you sell it.
- When determining how much gold is enough, keep in mind that financial advisors recommend keeping a maximum of 5-10% of your portfolio in gold.
