“Investing is laying out money now to get more money back in the future.” Warren Buffett
The purpose of investing is to set aside some money while you are earning and make it grow for the future. If you are a beginner in the world of investing and would like to test the waters, the first step would be to understand the workings of the investment ecosystem and explore the options available.
The selection of financial assets open to put your money in is vast and varied. While some are suitable for beginner investors, others are too complex and intricate that it requires the experience of a seasoned investor. Some are ideal for a short-term commitment, while others reap rich dividends in the long term.
Stocks, mutual funds, bonds and CDs, ETFs, futures, and options – the choices are plentiful in the investment world. However, a beginner may find them too volatile and hard to understand and predict.
Gold as an investment, in contrast, is a tried and tested investment tool for centuries. One of the arguments in favor of precious metals is that their worth will never be zero; they will always retain their intrinsic value unlike other choices available for investment.
If you are intrigued enough to learn more about investing in gold, read on.
What Is Meant By ‘Investing In Gold’?
The dictionary meaning of the word ‘invest’ means “to put money into financial schemes, shares, property, precious metals, or a commercial venture with the expectation of achieving a profit”. In continuation of this, ‘invest in gold’ means to buy gold as a commodity.
Our association with the precious metal as a store of value goes a long way back. Gold has been discovered in tombs from as early as 4500 BCE. It had an amazing run throughout the ages. Gold continues to dazzle everyone with its ever-increasing rate, making it an ideal tool to help your money grow.
Though it remains an enigma, gold is one of the most popular choices of investment among precious metals today. Now, investors have a wide range of options to invest in gold. From the simple and straightforward method to buy gold bullion to paper gold, a more indirect way to invest in gold.
Paper gold refers to investments in gold other than physical gold bullion such as gold mining stocks, gold mutual funds, and gold ETFs. There are more complex choices like futures and options, suitable for investors with more experience.
Gold price is the rate at which the commodity is traded in the global bullion market. Known as the spot price, the rate of gold fluctuates constantly during trading hours based on demand and supply as well as other market determinants. This is the base rate that you buy gold or sell.
Why should you buy gold?
The profit-making potential of the precious metal is proven time and again, making it a viable choice for investing. When considered as a long-term investment, the price of gold has always been consistent in performance.
The rate of gold has witnessed a mind-blowing 5600% increase from the fixed value of $35 per ounce of gold in 1970 to go past $2,000 for one ounce of gold in August 2020. In the last year alone, gold prices soared by 28%.
One of the compelling arguments favoring gold is that its value will never be zero. Though gold prices have shown volatility in the short term, it has always managed to shake off the bad spell and bounce back with renewed vigor.
History has taught us that gold prices have always gone up. Financial experts point out that gold will never lose its intrinsic value.
What to know more?
How to buy gold?
Once you have decided to invest in gold, the next step is to understand how the system works and which form of gold to invest in. Even as there are many choices to invest in gold, to gain the most from it, the best option is to buy physical gold bullion. The reason is simple enough.
With bullion gold, the value fluctuations are directly reflected while trading. Whereas, in other forms of gold assets, the price of gold is only one of the factors affecting its value.
The obvious place to buy gold in the physical form is from a gold dealer. The amount charged by the dealer would be much more than the current spot price. In addition to the spot price, a premium and mark-up are added to arrive at the final cost.
If you have time and patience, pawn shops and estate sales are good sources of physical gold. The cost would be much lower than the market rate in these places.
Now, it is possible to order bullion gold online and get it delivered to home. Instead, you may opt for one of the paper gold investments through a securities account. If planning to buy gold bullion, ensure its safe storage.
Including gold in your portfolio is good for diversification and brings down its volatility and risk. However, attention should be paid to the amount of gold in your portfolio. Experts warn against heavily investing in gold. After all gold is a commodity and even with its exemplary track record, it is hard to predict its future for certain. An allocation of up to 10% is usually recommended.
Let us see in detail how to buy each of the gold-related investments.
1. Gold Stocks
Investing in gold need not involve physical gold at all. If you like playing the stock market, it would be a good idea to put your money in stocks of gold mining companies and companies involved in its refining and production.
The most important thing to remember before taking the plunge is that the market can be volatile at times. To profit from investments, you need to spend time closely monitoring the ups and downs in the market. ‘Buy cheap and sell when the price is high’ should be your motto.
Again, buying gold mining stocks is one of the ways to invest in gold for inclusion in your portfolio. However, putting all your eggs in one basket is not recommended. When you invest in one type of stock exclusively, you are more exposed to market volatility.
2. Gold bullion bars
Gold bars are issued by government mints as well as private ones for retail investors. Gold bars need not necessarily mean the large ones that central banks maintain as a gold reserve. Gold bars are available in fractions and multiples of one ounce. In some countries, gold bars are sold in multiples of one gram.
The best place to buy gold bullion bars is from an authorized gold dealer. Nowadays, many private mints are selling their bullion through their online portal. This means you can buy them from the comfort of your home.
Bars are minted or cast for the sole purpose of investment. To make it transparent, each bar is inscribed with the details of the mint, its weight, and purity. The purity of a gold bar is in the range of 90% to 99.99% (pure gold).
Some of the popular bars are minted by Credit Suisse, Valcambi, Engelhard, and Johnson Matthey.
3. Gold bullion coins
Unlike bars, coins are minted for investment as well as numismatic value. Due to the dual-use, coins are made with artistic workmanship. And, this requires extra effort, making them more expensive than bars of the same weight.
Government mints issue sovereign gold coins with a face value but their intrinsic value will be much higher. The numismatic gold coins are priced even higher due to their artistic value, rarity, and popularity. Unless specifically interested in collecting rare gold coins, it is better to avoid them, as the premium is high and it is more difficult to liquidate them.
Again, the best place to buy gold coins is from a government authorized gold dealer. All reputed mints issue coins with weight, purity, and name of mint inscribed on its face. Like bars, coins too are available in a variety of weights to suit the need of retail investors. The purity of coins ranges from 90% to 99.99%.
Some of the most popular gold coins are American Gold Eagle and American Gold Buffalo, Canadian Maple Leaf, Austrian Philharmonic, Australian Kangaroo, and South African Krugerrand.
Related Article: Best Gold Coins For Investment
4. Gold ETFs and mutual funds
Gold Exchange Traded Funds (ETFs) are commodity ETFs that deal with a single asset – gold. ETFs work in a way similar to individual gold stocks and they are traded in exchanges in the same manner. However, like gold stocks, investing in ETFs does not entitle you to physical gold.
Gold ETFs include gold derivative contracts with the backing of actual gold bullion. Each unit of an ETF is a paper or dematerialized form of a unit of gold. They track the gold price in the global bullion market.
In other words, gold ETFs offer investors an opportunity to take advantage of the investment potential of gold without actually owning them. And, since it is a paper investment, the threat of loss or theft is eliminated and storage expenses may be avoided.
Another advantage Exchange Traded Funds have over physical gold is that smaller investments are possible with them. And, they are easier to buy or sell.
Gold mutual funds are open-ended funds that invest in gold mining stocks, units of gold ETFs, and some even directly in gold bullion. The value of each unit is based on the performance of the underlying asset/assets, which in turn fluctuates with the changing price of gold. As such, there is a direct link with gold prices but the factors affecting market volatility also play a role in its value swings.
A point to remember is that mutual funds that exclusively invest in gold or gold stocks and ETFs are rare. In many of them, gold-related investments form only a part. This will further dilute the reliance on gold prices for its value.
Mutual funds are actively managed, while ETFs are more involved in tracking the price of gold. Due to this difference in management, the expense ratio is considerably less for ETF.
However, investing in a mutual fund is much easier compared to an ETF and smaller investments are possible with mutual funds.
5. Gold futures and options
These investment choices offer investors to tap the potential of gold without a huge capital in hand. Gold futures are legally-binding contracts to trade pre-agreed quantities of the precious metals on a pre-specified date. In futures contracts, quality, quantity, time, and location of delivery remains fixed. The value of gold is the only variable.
Gold futures allow investors to dabble in the bullion market without physical backing. It also brings down the value variations in the anticipated future trade. Most gold futures contracts do not reach the delivery stage. Often this happens when an investor with a futures contract to buy initiates another to sell.
As the delivery happens only at the end of a gold futures contract, investors can practically eliminate the need for delivery and storage by offsetting the contract.
Options are again contracts that have either gold futures contracts or physical gold as the underlying instrument. It gives the investor the right to buy or sell gold at a specific value (strike price) for a predetermined amount of time. The point to note here is that options do not impose obligations on the investor.
If the value of gold goes above the strike price, the investor makes a profit. If it stays below the strike price by the expiry of the option, the option becomes worthless and the investor loses the premium for the option.
While futures are based on the current rate of gold, options have fixed gold prices. Futures require large capital investment, whereas options can be bought just by paying a premium.
Futures offer the lowest possible margins for large trading in gold.
6. Gold jewelry
Buying gold jewelry is an enticing prospect for many amateur investors as it also allows you to enjoy it rather than be kept securely in a safe deposit box or merely in the paper. However, from a pure investment perspective, jewelry is a poor choice.
The markup paid on jewelry for its workmanship and other extra expenses is quite high to recover in profits. Moreover, the purity of gold in jewelry is much lower than that of bullion bars and coins, though there are instances of jewelry made with 99.99% pure gold.
Buying gold jewelry from a regular jeweler is not a good idea from an investing perspective due to the high markup. With private sellers, auctions, and garage sales, there is a better chance of buying gold jewelry with less markup though this is a time-consuming, labor-intensive, and riskier process.
7. Gold Certificates
These are certificates issued by banks offering investors ownership of gold in the paper. Banks back these certificates with allocated or unallocated gold.
When you are buying allocated gold, the premium is high and you need to pay exorbitant fees for the secure storage of the gold with the bank. However, on the plus side, ‘allocated’ gold belongs to you and it cannot be seized or liquidated. In case the bank goes under, you can claim your gold.
Unallocated gold means the gold you bought with your gold certificate is not specific. The premium is considerably lower for this but if the bank liquidates, you could lose your gold.
Is buying gold a good idea?
Most financial experts consider investing in gold as a smart move. Due to its unique characteristics, gold acts as a hedge against negative economic events such as inflation, devaluation, recession, and market crashes due to global and regional economic and political uncertainties.
This means that when other investments fail due to adverse market conditions, gold prices rise due to increased demand. Investors have always considered gold as a safe haven and at the slightest hint of trouble, they switch to gold to safeguard their investments.
Before considering to invest in gold, you need to realize that most often it is not a short-term choice. Also, gold is regarded as a dormant investment as it doesn’t earn interest or dividends as other investments do. The profit from gold comes only when it is sold.
The allocation of gold in your portfolio should be limited to 10% as this is considered ideal for balancing its volatility and risk.
Want to know more?
When might gold be a poor investment?
Buying gold involves some amount of risk, expense, and inconvenience. Know them before going for it.
- Investing in physical gold necessitates the additional expenditure on secure storage.
- Gold jewelry comes with high markup and to seek out the ones with a lower markup requires patience, time, and perseverance.
- Gold is not a great short term investment choice.
- Investing in gold demands large capital.
- To profit from gold as an investment, patience, time, and constant monitoring of the bullion market are vital requirements.
- Unallocated gold may disappear if the bank goes belly up.
If you are not okay with one or more of the above, gold may not be a good investment choice for you.
Where does the demand for gold come from?
Most of the demand for gold comes from the jewelry sector – almost 50%. The share of gold as an investment stands second at around 30% and the gold reserves held by central banks comprise another 15%. The rest of the demand is from industries and technology.
Central banks maintain gold reserves to safeguard the purchasing power of their currencies. Gold is considered an emergency reserve in a crisis, a contingency against unanticipated events, and a kind of insurance.
Gold is used in medicine and dentistry. Its excellent electrical conductivity makes it ideal in the manufacturing of many components in the electronics industry.
What determines the price of gold?
Gold is a commodity and like any other commodity, its value is fundamentally decided by supply and demand. However, the simple market principles do not work the same way for gold always. This is the reason why gold is considered a unique commodity.
This may be explained further like this. When the economy is going through a rough patch, the value of assets come down naturally. However, gold has proved to hold its value in these tough times. The logic is simple enough.
When the going gets tough and the value of assets comes crashing down, people tend to switch to the traditional investment option of gold, as they feel it can protect their wealth. The heightened demand pushes up gold prices. The skyrocketing gold prices amid the pall of gloom in the financial sector further reinforces the concept of gold as a safe haven in troubled times.
This doesn’t mean that gold performs well only in bad times. When the economy is flourishing and people have money to spare, gold is again a favorite choice for many investors.
Does gold hold its value during an economic recession?
A recession or an economic downturn is a tipping point in the economic cycle when the ongoing growth peaks, plateaus and reverses into a contraction. Loss of business and consumer confidence are the hallmarks of a recessive economy.
As demand falls, businesses end up with less revenue, leading to layoffs and loss of jobs. This in turn brings down the demand further, forming a vicious cycle. The most visible effect of a downturn is a stock market crash.
As stock markets take a tumble, the knee jerk reaction of investors is to panic buy gold because of its reputation and performance in a crisis. This modern ‘gold rush’ further strengthens confidence in gold. As demand for the yellow metal goes up, it’s worth too rises.
Almost all economic downturns have witnessed the price of gold climbing to newer heights. This trend has only cemented the perception of gold as a safe haven, especially in hard times.
Gold as an investment comes with its own array of risks, just like any other financial asset. These include market volatility, theft, loss, and destruction, liquidity, and manipulation. For most investors, the advantages far outweigh these risks.
Irrespective of the type of gold related investment you choose, you will be able to realize profits only if it is retained for the long term. The price of gold goes up in spurts as a reaction to market events, at other times remaining mostly dormant.
Before investing, it would be advisable to monitor the movements of the spot price for some time to get a hang of how it works. Timing the purchase and sale is vital in improving the profit. For this, even after investing, regular monitoring of gold price should be continued.
Though it is a good investment, you should not allow gold to dazzle you and make you put a big chunk of your portfolio in it. You need to put a ceiling on the amount of gold in your portfolio. Experts place a ceiling of 10% as the ideal allocation for gold in any portfolio. More than this, it upsets the balance of the portfolio rather than help maintain it.
Finally, gold, with its unique array of properties, is the best bet for the diversification of a portfolio. Not only does it act as a hedge against a variety of economic maladies, but it also brings balance to a portfolio by bringing down the volatility and risks.