Investments

Why Not To Invest In Gold

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 10 minute read

Although investing plays a significant role in your financial well-being, this does not make it a walk in the park or a source of stress. Both stock and bond prices fluctuate over time. The motivations and factors behind the rise and fall in the value of these paper securities are not always clear.

Investing in precious metals, especially gold, is a popular alternative to the more traditional stock and bond markets. Gold is a safe haven for investors because its value is universally acknowledged, protecting them from inflation, falling stock prices, and political upheaval.

The Advantages and Disadvantages of Gold Investing

Gold is a good investment for many people for many different reasons, but it also has several serious disadvantages. Gold has low long-term volatility, is easily understood, and is well known as a safe haven investment. 

Potentially high transaction fees, storage complications, and a lack of liquidity are all disadvantages.

Advantages

Gold’s appeal to investors stems from the fact that it may be used as a diversifier in a broader portfolio and is also commonly considered as a hedge against the volatility of financial markets.

1. A Safe Haven

Investing in gold is a practice that dates back millennia. Formed into a universal currency some thousand years ago, it has been utilized for ornamental purposes since prehistoric times.

Given its historical track record, gold is seen as a haven by investors. There is always the chance that a financial asset, such as a stock or bond, can either increase in value or lose all value. Instead, gold has maintained its worth for thousands of years. All indications are that its value will only increase over time.

An asset having a history of appreciating in value is appealing to many investors during times of economic uncertainty.

2. Possibility of Inflation Hedge

The purchasing power of consumers is reduced due to inflation. You can feel the effects of inflation firsthand when you purchase a loaf of bread for $3 that your parents bought for you when you were a child for a mere $0.50.

Because central banks have the ability to expand the amount of fiat money — currencies backed by those central banks, such as the United States dollar — by printing more of it, inflation is a result of this practice. 

It does this by lowering the value of investors’ money, which forces them to purchase assets that they feel will appreciate in value as a result of the occurrence of inflation. The availability of gold is far lower than that of paper currencies such as dollars and euros. 

The only option to increase its size is to mine more, which is a process that is both costly and time-consuming. In addition, the amount of gold in the world is limited, which is something that cannot be changed regardless of how much is mined.

As a result, a significant number of investors look to gold as an inflation hedge. They do this not only because there is a limited quantity of gold, but also because there is a widespread belief that investing in gold is a prudent decision during times of high inflation.

However, there is significant debate as to whether or not gold is a very effective protection against inflation. An investigation conducted by the Wall Street Journal discovered that ever since the early 1970s, the performance of gold as a hedge against inflation has been, at best, uneven.

3. Minimal Prolonged Volatility

Investors experience volatility as one of the greatest threats to their capital. Stocks often appreciate over time, especially if you create a diversified portfolio or invest in index funds that mitigate risk by mimicking broad stock market indices.

Investments in stocks often grow in value over time, but that doesn’t mean they can’t lose 10%, 20%, or more in the short to medium term. There are a number of reasons why this volatility is troubling for investors.

To begin, it’s tough to keep going when your portfolio drops a lot of money in a hurry. If your investment horizon is too short or you need to liquidate your holdings quickly for some other reason, you may be forced to take a loss if you do so during a market downturn.

An article published in IIBM’s Management Review evaluated the long-term volatility of gold and silver and found that the former was significantly more stable than the latter. That’s why it’s a fantastic choice for conservative investors who don’t like to cope with portfolio swings.

4. Simplicity

There are a lot of people who only put money into items they have some familiarity with. The investment landscape of today, however, is complex for the average person. 

Although most individuals are familiar with stocks and the concept of investing in general, it can be challenging to understand the factors that influence the value of a single share, let alone the impact of derivative instruments like option contracts.

Investing in gold, on the other hand, is a straightforward decision because of its simplicity. Gold’s status as a precious metal goes back many years. It’s highly desirable as a personal possession. Gold’s worth is supported by the fact that there is a finite amount of metal available.

5. Diversifying Your Portfolio

Having a well-diversified portfolio is a must for each investor. Your entire investment could be lost if you put money into a single failing company through stock purchases. Investing in numerous companies spreads out the loss that could be incurred from the failure of a single one.

Increasing the portfolio’s diversification by including several asset classes is possible. If bonds as a whole were to decline in value, for instance, alternative investments might benefit.

This is because of the correlation principle, which explains why market values tend to move together. Stocks in a given economic sector or industry, for instance, often move up and down together. In a similar vein, as oil prices go up, oil firm stocks go up, and vice versa when oil prices go down.

Gold’s price is relatively unrelated to those of other investments. Stocks of mining companies are sensitive to fluctuations in the price of gold, although the impact of this factor is much smaller in other markets.

Including gold and other precious metals in a portfolio helps to make it more stable. Gains in precious metals can be used to cushion the blow of declines in other investments.

6. Tangibility

A lot of individuals like to put their money into things they can actually hold in their hands. Electronic trading platforms facilitate the majority of today’s investing options such as stocks, bonds, mutual funds, and exchange-traded funds. 

You can verify your ownership of the shares by viewing the corresponding numerical values in your brokerage account.

Unlike paper currency, gold and other precious metals can be held in one’s hands. Physical gold bullion can be purchased, held in one’s hands, and safely stored in one’s own house if one so chooses. 

Many potential investors choose investments with such a high level of physical security because they are wary of the uncertainty associated with less tangible options, such as stocks.

Disadvantages

Before putting money into gold, it is important to thoroughly analyze the dangers and problems that are unique to precious metals investing.

1. Cost

The high price of gold is a major disadvantage for investors. As everyone who has shopped for jewelry knows, gold is not cheap. An ounce of gold was worth roughly $1,100 in 2010. Gold’s price increased steadily between 2020 and 2022, eventually surpassing $2,000 per ounce.

Those just starting out in the investment world may find it challenging to make a sizable gold purchase at the current market price. Gold investing has additional expenses, like storage and transportation, that don’t apply to other assets.

2. Storage Concerns

Because of its physical nature, gold requires a secure location in which to be kept. Compared to purchasing other investments, that’s an extra layer of complexity you’ll need to deal with when investing in gold.

Owning gold in the form of bars or coins necessitates either a secure home safe or the services of a professional storage facility. Gold needs to be kept in a secure location, which can be either a personal safe or a company you pay for. Buying and selling gold requires you to cope with its storage and transportation.

For instance, SD Bullion’s storage fees are 0.29% each year of the gold’s value, with a monthly minimum of $9.99. Delivery fees are calculated based on the gold’s weight and the distance it must travel, plus a flat $25 fee for each transaction.

Exchange-traded funds that invest in gold allow investors to avoid the costs of transporting and storing physical bullion. Having gold on hand or paying for storage is an additional expense for these funds. Furthermore, it lessens the advantages of investing in gold, such as the investment’s physicality.

3. Liquidity

The gold market is also susceptible to the danger of low liquidity. There must be a third party involved in order to transact the actual metal purchase or sale. Following that, you’ll have to negotiate a price with them and organize shipping for the gold.

This is sometimes more challenging and time-consuming than trading a digital asset, such as a stock or bond. Gold that has value as a rare or collector coin is much more inconvenient to deal with.

Precious metals markets, like those of other illiquid asset classes like real estate and collectibles, are characterized by pricing inefficiencies and high transaction costs. Investment in gold exchange-traded funds (ETFs) can help with the precious metal’s liquidity problem, but they remove the advantage of holding actual gold.

4. Extremely High Short-Term Volatility

Gold is often considered a safe haven asset that can be used to protect wealth in the event of a market collapse. This might be the case in the long run due to gold’s low volatility. Gold’s price can be quite volatile in the short term.

The price of an ounce of gold, for instance, fluctuated between $1,780 and $1,865 between November 1 and December 31, 2021, before recovering to $1,825 by the end of the year. It’s possible that investors who seek a hedge against portfolio value fluctuations in the short term won’t find gold’s volatility appealing.

5. Speculative

Investment gold is a speculative asset. The scarcity of gold and its widespread status as a valuable commodity is the fundamental drivers of its price. When investors are worried, when stocks are falling in value, or when inflation is picking up, the price of gold tends to go up. There is no inherent worth in it.

Gold is purchased by investors who anticipate a profit from its resale to third parties. In contrast to other types of investments, this one has a lower risk. The interest payments received by a bondholder are one reason why this investment vehicle is attractive to potential buyers.

When you invest in gold, you are not buying it for its current worth or the income it may provide, but rather as a bet on its future price.

6. No Yield

Gold is not a yielding investment. Gold can only yield a profit if it is sold to a third party. This not only makes gold a risky investment but also implies it isn’t right for everyone.

Gold, for instance, is not a good choice if you need a steady stream of cash flow to support yourself while you wait for other investments to bear fruit. Investing in the stock market or bonds is preferable since they generate income in the form of dividends and interest payments. 

They will be able to maintain their standard of living without having to liquidate their holdings thanks to this income stream. Investors in gold who want to convert their holdings into cash flow will have to begin selling their holdings.

7. Taxes

The issue of taxes is a part of investing in whatever form. Physical gold investments, in particular, can cause a lot of trouble with the taxman. When investing in gold, capital gains tax is the primary tax consideration. 

This is the tax owed on the gain made from selling an investment. Therefore, if you invest $100 and make a $50 profit when you sell it for $150, you will owe $50 in taxes.

Stocks and bonds are two examples of assets where the difference between what you paid for them and what you got out of them on a cost basis is recorded and kept track of by your brokerage. In a way, this simplifies dealing with tax authorities.

The burden of keeping track of the cost of purchasing gold in physical form falls squarely on the buyer. When buying in bulk, it’s easy to lose track of the specific costs of all your purchases. This is especially true for little items like coins. Taxable profits and losses become more complicated as a result.

Stocks of gold vs. actual gold

It’s important to decide whether you want to invest in gold stocks or actual gold before making any gold investments. Both approaches have their advantages and disadvantages. You can exert the most influence over your gold investment by keeping it in physical form. 

In-person transactions and possession of the metal allow for greater control over its security and accessibility. However, logistics like warehousing and transporting can be difficult, and keeping tabs on your cost base for tax purposes can be even more so. The actual metal itself doesn’t generate any value, either, through dividends or interest payments.

You might also invest in exchange-traded funds that follow the gold price. This provides exposure to the asset class without the hassles associated with physically holding metal. However, this makes the asset less real in practice. Additionally, gold funds typically have management costs that eat away at your profits.

Shares in gold-related enterprises, such as mines or storage facilities, are also an option. The value of gold can be used as a proxy for how these stocks will perform. However, investing in them carries other risks beyond the fluctuating gold price, such as the strength of the management team.

Bottom Line

Throughout the centuries, gold has been used as a medium of exchange around the world. That’s why it’s a good choice for those who prefer to have something they can hold in their hands as an investment.

Whether or not gold is a good investment is, ultimately, up to the individual. Gold is a diversifier and, perhaps, a hedge against inflation and market volatility. Physical asset investments, however, can increase portfolio complexity due to the need to arrange for shipping and safe keeping.

If you’re looking to diversify or hedge your portfolio, alternatives to gold like cryptocurrencies and real estate may be better options. Gold might join these other investment options in your portfolio.

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