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Investing In Gold: What Are The Benefits And Risks?

As a valuable asset, gold becomes more attractive during times of economic uneasiness or political unpredictability. In this article, we've summarized the most important benefits and risks you should know before investing in gold
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Mann (Silvermann) is an experienced investor, financial expert and founder of The Smart Investor. Above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.

Review & Fact Check: Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Mann (Silvermann) is an experienced investor, financial expert and founder of The Smart Investor. Above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Mann (Silvermann) is an experienced investor, financial expert and founder of The Smart Investor. Above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.

Review & Fact Check: Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Financial Expert, The Smart Investor CEO

Experience

Baruch Mann (Silvermann) is a financial expert and founder of The Smart Investor. Above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.

The information in this content is not advice on financial, investment, tax or other matters. You can trust the integrity of our unbiased, independent editorial staff. We may, however, receive compensation from the issuers of some products mentioned in this article. See how we make money.

Table Of Content

You can’t talk of money and finance without mentioning gold at all.  History tells us that it’s been part of mankind’s economic life since its discovery as a precious metal. As a valuable asset, it becomes more attractive during times of economic uneasiness or political unpredictability.

There’s a long list of investors who have made their riches by just owning gold. Others who came in late in the game also have horror stories of how the value of their investments took a nosedive along with the prices of gold.

How To Invest in Gold?

Owning physical gold may not be the best way to invest in this commodity. You can start investing in gold by buying gold mutual funds, ETFs or bonds. These are a cheaper way to invest in gold. You also earn interest rates on your investment.

Alternatively, you can trade gold derivatives such as futures, options or CFDs. However, these are highly volatile and should only be undertaken by experienced investors

It’s quite easy to acquire gold if it’s in the form of jewelry but when it comes to investment, there are just typically three main forms, namely:

  • The gold bars and coins in their metal forms
  • Gold Exchange-traded Funds (ETFs)
  • Shares in gold mining companies or related gold-producing ventures

Hedge funds, institutional investors and short-term traders can also make a gold investment by choosing other vehicles.  They can go via futures contracts, options and/or CFDs.  However, these are all securitized products and carry more risk to investors.

For most investors, the first three choices are most advantageous when they want to buy gold. Each one of the three has its own upsides and potential downsides as well.

Investing in Gold During Inflation

Inflation is eroding the recent strong gains in wages and salaries for American workers, increasing pressure on the Federal Reserve as it considers how quickly to withdraw its stimulus efforts.

Job creation and pay increases have been much stronger during the pandemic recovery than they were following the Great Recession roughly a decade ago. However, in contrast to the years following the downturn, inflation is now accelerating and undermining Americans' confidence in the economy.

Investors have historically viewed gold as a way to hedge against inflation risk. However, historical data shows a mixed track record during past inflationary periods. Gold has yielded a negative return for investors during some of the highest recent inflationary periods in the U.S.

For example, gold investors lost 10% on average from 1980 to 1984, when the annual inflation rate was about 6.5%. Other options such as Treasury inflation-protected securities (TIPS), Real Estate Investment Trusts (REITs) and commodities give better returns during inflation.

Is Gold a High Risk Investment?

Gold is not a high-risk investment. Historically it has been regarded as a safe haven used to preserve wealth. This explains why gold performs well during times of inflation or economic uncertainty.  Gold is also characterized by a less volatile price movement than other assets such as equities. It trades at a relatively slow pace, fluctuating within tight price ranges.

As a result, the returns from gold may not be much when compared to other high-risk investments such as stocks or junk bonds.

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Gold Investing – The Advantages

Since gold is a commodity and doesn't depend on the economic situation, it has  a couple of great benefits for investors:

Many investors view gold as the answer and protection against inflation. Inflation is rising during the last year, while the expectations for 2022 (above 7%) are far higher than the “normal” inflation, which is 2-3%.

inflation in the US - graph

There are a lot of stories of governments with huge domestic debts (in their own currencies) that try to lessen the value of their money (in comparison to stable standards) so it will be less onerous for them to repay their debts.

You’re probably familiar with QE1, QE2, and QE3 in the US where the Federal Reserve did a quantitative easing by massively buying debts from member banks to maintain liquidity in the economy.

Practically any country experienced a monetary boost during the last decade. Its effect was that people who held on to their cash (as compared to those who had gold or precious art or houses) practically lost out.

Because the government can’t create a natural resource like gold, they cannot reduce its value like what they can do with their own currencies.

How Gold Perfomed in The Past?

History tells us that the amount of gold in the world has roughly risen with economic growth.  It has gone up accordingly with inflation (on average) and kept its (what economists call) “real value” exceedingly well.

To illustrate, note that in the early 1970s, one ounce of gold sold for about $35. Assume that during that time, you can choose to keep the $35 in cash or get an ounce of gold.  Being of equal value, they would allow you to purchase the same thing, like 30 gallons of milk or a fancy bicycle.

Now, if you had an ounce of gold today, it would still allow you to buy a fancy bicycle plus accessories, safety gears, sneakers, and spare tires.  With the $35, you can still buy a kiddie bike or a second-hand bicycle.

What we're saying is that you would have lost a good amount of wealth if you decided to keep the cash intact.

If you had decided to keep your money in physical gold, you would have multiplied its value by around 33 times.  The value of gold has increased while the value of the dollar has declined during the same period.

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Perhaps the number one reason for gold’s popularity as an investment option is in knowing that the value is going to go up firmly over the years. Historically, you may see that the price dips once in a while – but it always rebounds.

Looking at the historical chart as the big picture, you can safely predict that gold is going to increase in worth ten or twenty years from now.

In stocks, bonds, or mutual funds, you always have to hope that a specific company or industry is doing well because the value of your investment is largely dependent on their performance.

Not so with gold.

Although the current state of the economy does affect gold prices, a dipping economy does not automatically bring the gold prices down with it.  In fact, it often does the opposite. When the economy is uncertain, people tend to invest more in gold, and this pushes the price even higher.

Not many would realize it but investing in gold is an excellent strategy to diversify your portfolio.

We’ve said that the price of gold performs incredibly well even during times of uncertainty. Therefore, a great approach to balance the volatility and returns within your investments is to make gold a part of the roster.

More importantly, with gold being part of a diversified portfolio, you can protect yourself from a “wealth wipeout” in extraordinary situations. No severe economic depression or a stock market crash will zero out your investments – gold will still be probably standing tall after the smoke clears.

An EFT is one of the best options for gold because it beats having to keep the yellow metal in your vault or secret place. This way, you only concern yourself with the price and forget about trying to keep it safe from robbers and other adverse physical conditions.

Let’s not kid ourselves.  You invest because you want to make more money and with it comes the natural fear that your investment may somehow end up worthless in the end.

Obviously, that fear becomes less when it comes to gold investing.  For example, if we were to have a repeat of the 2008 stock market crash, you’d be penniless if your portfolio carried only stocks, bonds, and mutual funds.

This is why investors consider gold as a safe haven during times of uncertainty, whether political, financial, or economic.

If an investor invested substantially in physical gold for the long-term, he would probably be sleeping better.  He knows that a financial crisis or global meltdown will not really affect his gold investment negatively.

On the contrary, the price of his gold would normally go up during such trying times because more people turn to physical investment when they see that the financial markets are not giving them a bright hope.

The amount of official reserve assets held in Gold have increased to $494 billion as of 2020, according to data from the FED. The reserve assets held in gold increased from $134 billion in 2005 to $433 billion in 2012. However, the reserves fell by $118 billion in 2013 to $315, then to a further $277 billion in 2015. The government then increased the reserve assets held in gold from 2016 to 2020, when the reserves attained a 20-year peak of $494 billion in asset reserves.

Chart: U.S. Official Reserve Assets Held in Gold 2000-2020 (in billion U.S. dollars)

Gold Investing – The Disadvantages

Like any other investment  –  investors should be aware of the main risks of gold investing:

A large number of financial experts, including Warren Buffet, espouse the convention that your investments should be income-generating. Gold fails this condition because it does not produce anything when you just buy and hold it.

If your objective is to amass a lot of wealth, then it’s better to find an asset that will make you richer.

Warren Buffet began in this direction even as a boy when he bought his first property.  He knew that the value of the land would appreciate but above that, he also saw the potential of earning from the property.

Gold stocks attract growth investors more than they do income investors.  These stocks normally go up and down in synch with the price of gold.  However, you can find well-managed mining companies that are able to turn in a profit even when the price of gold falls.

You will see that the prices of gold stocks tend to magnify the increases in the price of gold.

Here’s a fact:  gold and stocks don’t always behave the same way at the same time.

For example, when the stock market is booming, gold is dragging behind.  Since the market has a proven track record of going higher over time, having gold as your sole investment could put you in a risky situation.

Let us show you another deficiency of gold.  Suppose you were back in the 1800s and had a choice to put $10,000 in either gold, bonds, or stocks.  Which of the three do you think would come out ahead?

If you are a savvy investor, gold would fall last on your choices because it performs very poorly in relation to the other two.

Here’s how it will look after 200 years in our present time…

  • The gold will be worth just $26,000.
  • The stocks will have a value of $5,600,000,000.
  • The bonds will command about $8,000,000.

It might shock you but when you look at historical returns, it turns out that gold pales as an investment choice in the long run.

Over the years, gold prices have been so volatile that there is a valid reason to doubt its feasibility as a safe haven investment.

The price of gold has to contend with several pressures such as a strong US dollar, shrinking demand from India and China, central banks of other governments and general world peace because gold becomes more popular during periods of crisis.

After peaking in 1980, the price of gold has gone down by 65% in less than two and a half years. You can see the volatility of this supposedly safe and stable asset class.

Is it Better to Buy Gold or Gold Stocks?

Gold stocks are a good option to invest in gold rather than owning them physically. They also come with the added benefit of trading like regular stocks. The difference is predicated on exposure to risk and liquidity.

Gold stocks are more liquid and are easily tradable like any stock. Gold stocks may track the price of physical gold but are also susceptible to other types of risk which can have an impact on the stock price.

For example, the stock of a gold company that is heavily in debt or experiencing losses can be trading lower regardless of if the price of gold is up. However, in terms of returns, it is better to invest in gold stocks than owning gold physically. 

The Bottom Line

Every investment has its unique advantages and disadvantages. If you don’t relish the idea of holding physical gold, investing in shares of mining companies may be your cup of tea.

If you buy into the idea that gold is the best protection against inflation, then you can invest in coins, bullion, or jewelry to lead you to the way of gold-based abundance.

And finally, if your foremost interest is in using leverage profit from appreciating gold prices, the futures market is waiting for you. Just remember that there is a reasonable amount of risk that accompanies any leverage-based investment.

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FAQs

There are several advantages of investing in gold bonds instead of owning physical gold. Gold bonds allow you to get in at a lower price and also reap the benefits of the price movement.

Investors also earn interest rate on gold bonds which gives it a higher return than holding physical gold. They are also cheaper way to invest because investors don’t incur storage costs. Lastly, payments are guaranteed since they are issued by the government.

Same rate: Gold ETFs are traded on an exchange with  transactions carried out at market prices. Units if the gold fund can be bought and sold rate, which is not the case with physical gold. The price of physical gold varies by geographical location.

  • Purity: Gold funds only invest in real gold which has been verified and is registered. Investors in the fund can be assured that they are investing in real gold based on the due diligence carried out by fund managers.
  • Liquidity: Gold ETFs are also liquid., which means investors can liquidate their holdings at any time at the current market price. This convenience of trading on an exchange cannot be matched by transacting in physical gold.

Gold futures are attractive because they allow investors to trade the commodity without having to pay the whole price up front.

Similarly, speculative investors and traders can utilize gold futures to participate in the markets without owning the metal and to convey investor emotion on the price of gold in the future. This makes gold futures ideal for hedging and speculation.

Gold ETFs are traded like shares on a stock exchange and as such have lower transaction costs. This enables investors to profit from the price movement of the commodity while avoiding the costs and inconvenience of storing physical gold.

Investment in gold ETFs yields dividends which can be reinvested to increase the portfolio size. This contrasts the scenario in owning physical gold whereby you don’t earn interest or dividends. Gold ETFs are also more liquid to trade than physical gold. 

Gold has a much lower rate of return than other assets. Returns on the commodity have been very poor in the last decade. The meager rate of returns on gold investment cannot make on rich. 

On the contrary, investing in gold could increase your losses. The asset has failed to live up to its status as an inflation hedge. In the last year, Gold has last lost about 5% of its value, while inflation has gone up by 5.3%

Governments are unable to “print” gold or Bitcoin.  This is the primary reason why they are thought to be unaffected by inflation. Both gold and Bitcoin are unforgeable. Bitcoin transactions are recorded on a public ledger, and more currency cannot be added to the ledger. Gold is easily identified and its purity can be determined.

Finally, both gold and Bitcoin are nearly indestructible. Gold is prone to wear and tear if not handled with care. It will, however, never disappear. The only way for a cryptocurrency to disappear is for the entire world to lose internet access for an extended period of time.

When it comes to investing your money in different assets, silver is an excellent choice because it provides a good return on investment. Silver is viewed as a safe haven investment in uncertain times and inflation, acting as a hedge against inflation and equities.

Silver tends to outperform gold during bull markets or commodity supercycles. Furthermore, its current price is lower than that of gold, making it a more cost-effective way to invest in precious metals. As a result, investing in silver is a good idea in case of an inflation.

When it comes to choosing the right gold dealer, there are numerous factors to consider. Gold prices can vary depending on the dealer. As a result, you should look for a dealer who does not overcharge for the gold itself. Furthermore, when purchasing gold, you must consider the fees.

Choose a reputable dealer. If you go to your local dealer, you will be able to take physical delivery of the gold after making a payment. Online dealers, on the other hand, must be thoroughly vetted before making a purchase.
Regrettably, gold scams are very common. Because there is little regulation in the industry, it is not difficult to find dealers who appear to be legitimate but are not.