Investing in gold is a popular way to diversify a portfolio and protect against political unrest and inflation. There are many different types of gold investments, ranging from physical currencies and ingots to exchange-traded funds, derivatives, and digital gold. Knowing which type of gold is right for your investment portfolio is key. Adam Hayes, Doctor of Doctorate, and Skylar Clarine, a fact checker and personal finance expert, provide insight into the different types of gold investments.
The three main options for investing in physical gold are ingots, coins, and jewelry. When most people think of investing in gold, they think of big, shiny gold bars locked in a vault. Nowadays, you can buy gold in many different ways. These range from physical currencies and ingots to exchange-traded funds (ETFs), derivatives, and digital gold. Bullion is perhaps the best-known form of direct ownership of gold.
Many people think of gold bars as the large gold bars found in Fort Knox, Kentucky. In reality, gold ingots are any form of pure or nearly pure gold that has been certified for its weight and purity. This includes coins, bars, and other forms of gold of any size. A serial number is also often attached to gold ingots for security reasons. For decades, sovereign governments around the world have issued large quantities of gold coins.
Investors usually buy currencies from private traders at a premium of between 1% and 5% above their underlying value in gold, but in recent years the premium has risen to around 10% in some cases. Old and rare gold coins have what is known as numismatic or “collector's” value above and beyond the underlying value of gold. To invest strictly in gold, focus on widely circulated coins and leave rare coins in the hands of collectors. Some of the widely circulated gold coins include the South African Krugerrand, the United States Eagle, and the Canadian Maple Leaf. The main problems with gold bullion are that storage and insurance costs and the dealer's relatively large margin hinder profit potential.
In addition, buying gold bullion is a direct investment in the value of gold; each one-dollar exchange in the price of gold will proportionately change the value of a person's holdings. Other investments in gold such as mutual funds can be made in smaller dollar amounts than bullion and may not have as much direct exposure to prices as bullion. An alternative to buying gold bullion directly is to invest in one of the gold-based ETFs. Each share of these specialized instruments represents a fixed amount of gold such as one-tenth of an ounce. These funds can be bought or sold just like stocks in any brokerage account or individual retirement account (IRA).
Therefore this method is easier and more profitable than owning ingots or coins directly, especially for small investors since the minimum investment is only the price of a single share of the ETF. The average annual expense ratios of these funds are usually around 0.61%, much lower than the fees and expenses of many other investments including most mutual funds. Traditional mutual funds tend to be actively managed while ETFs follow a passive index-tracking strategy and therefore have lower expense ratios. However for the average gold investor mutual funds and ETFs are now generally the easiest and safest way to invest in gold. People often use futures because the fees are very low and the margin requirements are far below traditional equity investments. Some contracts are settled in dollars while others are settled in gold so investors should pay attention to the specifications of the contract to avoid having to receive 100 ounces of gold on the settlement date. Futures options are an alternative to buying a futures contract directly.
These give the option owner the right to purchase the futures contract within a specified period of time at a pre-established price. One of the benefits of an option is that it takes advantage of your original investment and limits losses for the price paid. A futures contract purchased on margin may require more capital than originally invested if losses increase rapidly. Unlike a futures investment which is based on the current value of gold, the disadvantage of an option is that the investor must pay a premium on the underlying value of gold to own the option. Due to the volatile nature of futures and options they may not be suitable for many investors even so futures are still the cheapest way (fees plus interest expenses) to buy or sell gold when investing large sums.
Companies that specialize in mining and refining will also benefit from the rise in price of gold. Investing in these types of companies can be an effective way to profit from gold and can carry a lower risk than other investment methods. The largest gold mining companies have extensive global operations; therefore business factors common to many other large companies influence the success of such an investment.