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For most of human history, gold has been considered one of the most valuable commodities on the planet.
Cultures throughout the world have used it to symbolize wealth and power over others.
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While we typically use paper money to facilitate transactions today, gold can still be an effective tool for those looking to diversify their investment portfolios.
Let's take a closer look at whether investors should buy physical gold or purchase shares in a gold exchange-traded fund (ETF) to gain exposure to this commodity.
The Differences Between Physical Gold and Gold ETFs
Physical gold describes anything that a person can touch or otherwise interact with using their other senses. Gold has been discovered and mined in many places throughout the United States including California and Alaska.
There is a good chance that someone interested in investing in gold already has jewelry, a watch, or similar items at home that are made from this material.
It's also possible that you have plates, cups, or other objects in your home that are fully or partially covered with it. Finally, individuals may have coins that are made from pure gold or have some amount of gold inside of them.
An ETF is a hybrid between a stock and a mutual fund, which means that investors can have exposure to gold without having to purchase a coin, gold bar, or similar items. An ETF is like a stock because it can be traded at any time, which provides an investor with greater liquidity.
It is like a mutual fund in the sense that multiple investors are pooling their money to acquire a share of a single security. A gold ETF will typically track a gold index or offer a collection of stocks from companies that either mine, sell or distribute it.
Is Physical Gold a Good Investment This Year?
As a general rule, gold is an effective hedge against inflation as well as a safe haven during times of economic uncertainty. Generally speaking, during a recession or political unrest, investors tend to move their money from stocks to gold, which means that its value will likely go up.
Therefore, it may be an effective addition to a portfolio for anyone who is concerned about a loss of purchasing power or who has concerns about a short or long-term decline in stock prices.
Of course, there are several questions an investor must ask before determining if buying gold is an effective use of their resources. For example, it may not be worth buying for those who don't plan on holding it for several months or years.
However, investors who are looking to keep coins or bullion in their portfolios as part of a buy-and-hold strategy may benefit from acquiring these items.
Physical gold may also be ideal for those who are looking for an effective way to save for retirement. The Internal Revenue Service (IRS) allows individuals to hold physical gold in an individual retirement account (IRA) assuming that the acquisition meets government standards.
Typically, it can be held in either a traditional or Roth gold IRA, which means that it may help you with your tax bill both today and during retirement. A traditional IRA is funded with pre-tax dollars, which means that you could save thousands of dollars when you file a tax return in April.
A Roth IRA is funded with contributions that have already been taxed, which means that you don't have to pay taxes on withdrawals in retirement. In either scenario, your account balance will grow tax-free throughout your working life.
As you are allowed to have more than one IRA, it may be possible to have both a traditional and a Roth account. This may allow you to partially avoid a tax bill today and enjoy tax savings later in life.
The Potential Downsides to Buying Gold ETFs
There are several issues as it relates to investing in an ETF that might make physical gold more appealing for most people who want to acquire it. First, an ETF is passively managed, which means that investors won't get a lot of help from the person overseeing their assets.
Conversely, many companies that hold gold on a client's behalf will have a customer service team dedicated to answering questions about gold, their account, or anything else regarding their portfolios.
Furthermore, although an ETF is passively managed, they still carry management fees. Although many companies that store gold held in gold IRAs also charge fees, they may be waived or reduced. Even if management fees aren't waived or reduced, the typical investor will generally get more for their money than they would by investing in an ETF.
Those who invest in a leveraged ETF may lose more than their initial investment if the value of the underlying index goes down. For instance, an ETF that uses three-to-one leverage will invest $3 into an asset for every $1 placed into the fund.
Therefore, if the asset loses $1 in value, investors might lose up to $3. Depending on the extent of an investor's losses, a broker may initiate a margin call that involves liquidating other parts of a portfolio to cover the shortfall.
Meanwhile, physical gold is purchased with cash to ensure that losses are limited by the size of an initial investment. However, as gold retains its value, there is a relatively low risk that anyone will lose a significant amount of their capital.
Finally, the price of an ETF may not always track the price of the asset it is designed to follow. Let's assume that an ETF was designed to track the spot price of physical gold. Let's also assume that gold was trading at $2,000 an ounce when an investor decides to buy shares in a gold ETF.
An ETF might quote a price of $2,050 to buy shares in a physical gold fund because of lag in the network used to process the transaction.
When buying from an authorized dealer, an investor will pay roughly whatever the spot price is at the time of the purchase. It's possible that a dealer will include a markup to ensure that it makes a profit, but this markup will generally be more predictable than the potential differences that an investor might encounter when buying an ETF.
Where Can Investors Buy Physical Gold?
Physical gold can be purchased from several different sources including private sellers, pawn shops, and authorized gold brokers. Buying from private sellers may be ideal for those who are looking for a quick and easy transaction process. It may also be ideal for individuals who are looking for unique products that brokers or pawn shops might not have.
For example, a buyer might be able to obtain a watch from a friend or colleague that doesn't run properly but contains a tangible amount of gold. In such a scenario, a buyer might be able to leverage their relationship with the seller to the gold at a discount to the spot price.
One potential drawback to buying from a private seller is that it may be difficult to verify the authenticity or the quality of the gold being sold. While some private sellers might grade their products or provide certificates of authenticity, this may not be possible in all cases.
This is because it may cost a significant amount of money to have a product graded or to otherwise verify that what you're buying is legitimate.
This may also be true when buying gold from a pawn shop or other small retailer that doesn't necessarily specialize in selling it. Therefore, it's always in a buyer's best interest to do their homework as it relates to the retail value and authenticity of an item before buying it.
Doing so may be the only way for a buyer to protect their investment and their ability to maximize the return on that investment.
It's also important to note that investors might not be able to hold gold in an IRA unless it is purchased from a dealer approved by the IRS. Therefore, those who are planning on buying physical gold as means of saving for retirement are encouraged to do their research ahead of time.
While it may be possible to retain any gold purchased from an unauthorized dealer, the IRA itself may be dissolved or otherwise subject to greater levels of scrutiny. Fortunately, it's generally not necessary to pay capital gains or other taxes on gold until it is sold.
Therefore, even if an IRA is disallowed for any reason, it may be possible to avoid any accounting issues until several years or decades after the purchase is made. Investors who have questions or concerns about the tax implications of a transaction may want to talk to a financial or tax adviser.
Tips for Storing Physical Gold
Perhaps one of the key benefits of buying gold ETFs is that investors don't have to worry about storing their investments. However, the need to store coins, bullion, or other types of physical gold shouldn't scare an investor away.
In many cases, storing gold is as easy as buying a safe and keeping it in there at all times. Alternatively, investors can choose to keep their gold in a safe deposit box at a local bank.
Those who purchase gold to be kept inside of an IRA will work with their plan custodian and gold provider to determine where it will be stored.
In most cases, gold is kept in a secured facility that may also have climate controls and other tools that help to protect the investment a client has made.
This May Put Physical Gold Ahead of Gold ETFs
Buying either physical gold or an ETF that invests in gold or gold companies may help protect investors against inflation. However, there is one key difference between the two that might tip the scales in favor of buying something that an investor can see and touch.
That key difference is that gold itself is not correlated with the stock market while a gold ETF is vulnerable to downturns in the market.
This is largely because an ETF can trade similarly to a stock, which may be problematic for two reasons. First, stock markets tend to rise or fall as a unit, which means that a bad day for the Dow 30 is likely a bad day for anyone who owns shares in an ETF.
Next, as shares in an ETF trade like a stock, investors have the chance to sell their shares short. In other words, some people are actively trying to reduce the value of an investment, which isn't ideal for those who are nearing retirement.
It also isn't ideal for those who are looking to preserve their capital in general. Short sellers are something that investors are unlikely to encounter when buying physical gold.
Investing in physical gold may be an effective way to help individuals of all ages achieve their financial goals both now and in the future. As the tangible product can be included in a gold IRA, it may also be ideal for anyone who is looking for potential tax savings as well as the other benefits that this mineral can provide.
Of course, it's always prudent for investors to review their asset allocation, timeline, and other needs before deciding where to place their capital.
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