Pros and Cons of Having Gold in Your Portfolio
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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, gold bars and ingots. They also have the option of purchasing gold-backed assets like stocks, mutual funds, exchange-traded funds (ETFs), futures or other derivatives.
Physical gold investments allow you to own the precious metal, which gives 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.
On the other hand, gold-backed assets — such as gold stocks and gold 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 wide range of options makes it easier to add gold investments to your portfolio. But before you decide to venture into the gold market, make sure you weigh the pros and cons of investing in precious metals. After all, it’s an asset that, like all investments, comes with risk.
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.
But investing in gold can also come with storage costs (in the case of purchasing tangible assets like gold coins and gold bars), capital gains taxes and a potential performance lag in your portfolio. If you’re a novice investor, using complex instruments such as futures and swaps also exposes you to a bigger potential risk of loss. And as with any investment, past performance of gold as an investment is no guarantee that an asset will grow while within your portfolio.
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. When assets like stocks lose value, others like gold may gain and help offset your losses.
The price of gold tends to move inversely to the stock and bond markets during periods of economic stress, and the price of gold is typically less adversely affected by downward movements in these asset classes. When markets fall, gold can potentially offset the losses — either wholly or partially — because its price tends to rise during market downturns.
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.
During periods of inflation, the purchasing power of the dollar decreases and central banks typically raise interest rates. Gold demand, meanwhile, tends to increase during these time periods as investors buy hard assets like precious metals when they realize that they’re losing purchasing power due to inflation.
That said, gold doesn’t always rise during periods of inflation, and it’s important to remember that gold is best as a long-term investment that you plan to hold for years.
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. When political and economic events impact market performance and traditional investment options (like stocks and bonds) are under stress, investors often turn to gold because its price may rise if people increasingly use it as a store of value for their wealth.
This makes the precious metal a potential hedge against volatile economic conditions. Investors tend to add gold assets to their portfolios when they anticipate hard economic times that may devalue the dollar and other assets. Because of this, gold is largely considered a safe-haven asset that may store value regardless of the state of the economy.
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.
Gold can add liquidity to your portfolio because it’s one of the easier assets to convert into cash. That’s especially the case for gold-backed paper assets like the stocks of gold mining companies or ETFs that are backed by physical gold.
There’s rarely a shortage of demand for the precious metal, but one of its downsides is that physical gold may require more logistics to sell compared to gold-backed paper assets like shares of gold ETFs. Even if you know how to buy gold, you may need to find a buyer and then transport your physical metals to them in order to sell it. If the asset you’re looking to buy is in high demand, you might not have enough time to execute these transactions. Therefore, to a certain extent, gold bullion has the same liquidity problem as other commodities that are hard to convert to cash — like real estate. The best gold investment companies will let you borrow against the value of your gold bullion without having to sell your holdings, which is another way gold can provide liquidity.
The cons explained
Despite its many advantages, buying gold as an investment does entail risk, and it doesn’t guarantee positive returns in your portfolio. Below are some specific disadvantages of investing in gold.
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. This cost is one reason why some investors prefer to buy gold mining stocks or other gold-backed paper assets.
To learn more, read our guide on how to insure physical gold.
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).
Gold and other precious metals are classified as collectibles by the IRS. If you sell physical gold after holding it for more than a year, you’re subject to long-term capital gains tax at your marginal income tax rate, up to a maximum of 28%. This is higher than the 20% maximum long-term capital gains tax rate that other investments like stocks are subject to.
If you hold your gold for less than a year and sell it at a profit, you’ll be taxed at regular income tax rates — but keep in mind that financial advisors typically recommend not using gold as a short-term investment.
A gold IRA offers the same tax benefits as a conventional IRA, but gold IRAs incur costs of their own. The best gold IRA companies have low fees and transparent pricing.
To learn more, read our guide on how gold is taxed.
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.
If you’re trying to build a portfolio aimed at generating passive income in retirement, a gold IRA could make sense, but be mindful that it does not produce yield.
How much gold should be in your investment portfolio?
Experts say alternative assets — including gold — should comprise no more than 5-10% of your investment portfolio. This leaves room for other asset classes, like securities. Income-generating assets will help your nest egg grow over time as your contributions compound, while gold doesn’t generate income until you sell it.
You can invest in gold indirectly by buying stocks in gold mining companies or by purchasing shares in mutual funds or ETFs that hold gold-backed assets or baskets of gold mining companies. The advantage of investing in gold this way is that you will own a stake in these companies or funds and can earn dividends, unlike physical gold investments which don’t generate yield.
Since there’s never a one-size-fits-all approach to building a portfolio, if you have questions about whether or not gold is a good investment for you, get advice from an unbiased professional like a certified financial planner.
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.