Should You Be Investing in Gold?

The Downsides of Investing in Gold May Outweigh the Benefits

Early May has shown the price of gold reach record levels, mostly due to continued reports regarding Greece’s financial situation. In capricious times of change economists have always recommended investing in gold due to its reputation for being able to weather the storm and come out on top as an inflation hedge. Over the past three years, gold has seen an increase of 84% in value, and during the last year gold has seen gains and losses of over 12% within the same quarter.

With all of the recent news reports and the many television and radio commercials for gold investment opportunities an investor can easily become persuaded to bet the farm on gold. A chic Abu Dhabi hotel even installed a gold dispensing vending machine recently! This constant media exposure overshadows many of the downsides of investing in gold. When looking at the big picture, gold is not always the safe and smart choice it’s made out to be. Here are a few reasons you may want to put your blinders on to the gold frenzy.

Gold is Volatile Just Like Stocks

The price of gold isn’t set by any one entity. Instead,  it is controlled by the fluctuations of global markets, which can take surprising turns, like in Dubai and more recently in Greece. Political situations, civil unrest, even natural disasters can affect the price of gold. The recent instability of global markets should be a warning sign to those investing in gold that as quickly as prices go up they can come right back down.

Gold is simply too volatile to be a suitable single investment to guide your portfolio as it rises and falls with the unpredictable nature of the global market. As each country’s market begins to recover it’s common for the government to raise interest rates, which put significant pressure on the price of gold. National governments such as France and the United States have continued to introduce stimulus packages and print more money, thereby increasing the potential for inflation. Inflation is one thing gold bugs say that gold fights against, but that’s not entirely true. Over the long term gold has typically just barely edged out the rate of inflation.

Gold may be up 84 percent in three years, but it has been a wild ride. Most recently, gold fell 12.6% from December 2nd to February 8th, then rebounded 16% in the next three months. And you thought only stocks were capable of wild price swings like that!

No Compound Interest or Dividends

Investors also miss out on compounding interest when they invest in gold. The economists who suggest that gold is the best long term investment overlook the returns compounding interest and regular dividends bring. Gold doesn’t earn a profit, nor does it receive a dividend payment for superior performance. Gold may have staying power, but it  generally cannot compete with the additional earning power of reinvested dividends. Marketing director Jamie Hyndman explains, “The quintessential thing that grows long-term returns is the effect of compounding.” Also, gold does not have to ability to create value the way a stock can. Publicly traded companies have to ability to introduce new products, expand to new markets, and draw in new investors. Gold can only sit there and wait for the global market to dictate its value. Investing in gold may seem safe, but it can also keep investors from reaping the rewards of compounding interest and regular dividends.

The Burdens of Owning Physical Gold

Some investors need to see and touch their assets and have been convinced that investing in physical gold is best way to empower their money. The fact that there are so many infomercials peddling gold bars and coins should be a red flag in itself, but there are more concrete reasons that investing in physical gold can be burdensome and risky. Investors must first find an appropriate place to store their gold. Keeping the gold at the investor’s residence puts the gold at risk of theft or damage. You can put it into a deposit box at the bank, but then you need to pay for the box, only have access to it during banking hours, and then must have it reexamined when you’re looking to sell.

Plus, there’s not a lot of liquidity. If you own stocks, bonds, mutual funds, or even keep money at the bank you have almost immediate liquidity. If you want to sell something you have or cash in it’s usually an instantaneous transaction as long as it’s during business hours. If you have a bag full of $5,000 worth of gold coins you can’t just turn it into cash instantly with the click of a mouse. You’ll need to go shop around to dealers who work in gold and see what you can get for it.

The gold dealers who sell bars and coins to investors also mark up their gold sometimes 5% or more over the market price, warns Scott Carter, vice-president of a major gold trading firm. Another drawback of investing in physical gold are the taxes you must pay when selling your gold. Certainly you typically pay capital gains tax on regular investment earnings, but the IRS considers gold a collectible item, which makes the tax rate on gains made from selling gold rise to your personal tax rate which is often 25% or higher. When you must pay a premium to buy the gold, pay a bank to store the gold, and then pay the government to sell the gold, how much money can really be made on an investment just touted to hedge against inflation?

There is Still a Place for Gold in Your Portfolio

Think long and hard before deciding if investing in gold is the right move for you. Hype and hysteria can lead investors in the wrong direction and investing in gold is not the sure bet many people make it out to be. Remember when owning a home was a sure bet? I don’t need to remind you that asset bubbles can and do happen and commodities such as gold are not exempt. Remember, you make money when you buy low and sell high, not the other way around. With gold reaching record highs do you think you’ll be buying in at the low end or the high end?

But gold is just one of many different investments you should be considering when creating a diversified portfolio. Owning some commodities or precious metals in particular can give you a little extra diversification. What you have to be careful of is making sure you don’t get gold crazy and throw caution into the wind as you sell all of your other investments and dump it into gold. That’s no safer than dumping your retirement nest egg into one particular stock. And instead of buying actual gold bullion or bars you might want to look at the number of ETFs that track gold so you can eliminate the burdens of owning physical gold and maintain liquidity.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

19 comments
Solar Water Pumps Manufacturers
Solar Water Pumps Manufacturers

My two cents are that while gold is a fairly safe investment, it is still risky and there is still volatility here. Just because gold has an inherent value does not mean this value cannot change just like a company's stock can. I think there is definitely room in anyone's portfolio for precious metals but I don't think you want to overallocate.

steve
steve

I'm not an investment expert, but I think precious metals still have some considerable upside just because I don't have much faith that the US economy will actually rebound.

And then add the effect of peaking energy supplies and how that curbs growth -- not to mention the wave of revolutions in the Middle East -- and I think gold's best days are still ahead.

Also, I think precious metals have been artificially suppressed in order to prop up the US dollar. That's changing as we speak. I'm not saying I understand this completely but I do feel good about owning metals right now.

aaron David
aaron David

i think it sums it up when it reads the key to investmests is to buy low and sell high. Investing is all about being original. The less original u are the less u make out. At this point with so many many people investing its like a a row boat getting weighed down. If you want to invest your money wait for a down swing in the economy and buy into something alot of other people havent yet. Then sell when it upswings but dont be greedy. There is such a thing as holding too long. Now I've never sold or invested in my life.But the principles seem simple. So simple that even drug dealers follow them.As for a sure thing no such thing exists, and what is the point of investing in something that pays off on such a slow end. You might as well just go put your money in the bank and dont waste your time. Everything in life is a risk. The bigger the risk takers the bigger they're successes and the bigger they're failures. But why do what evey one else does, originality is what has made great men great.

Bernz
Bernz

I'm a bit concern about the price of gold myself. Although I have thoughts of investing in gold since last year, I just can't pull the trigger to do it. And this thing just keeps on getting higher. Is there an end into it, I really don't know. The likes of John Paulson and other hedgies are still investing though. I think there are more safer investments out there.

Dan Cassidy
Dan Cassidy

Eventually there will be a Gold bubble. You have to know when to get out. We probably will see a correction soon and another rally up with Gold and Silver. For most people with not a lot of money to invest in metals, Silver might be the better option. It's the poor man's Gold.

The truth is it does not matter how much Gold or Silver you have when and if society breaks down. Do you really want to be walking around with Gold and Silver with angry mobs walking around looking for food?

If your worried about hedging against currency inflation, then Gold and SIlver will be key, but don't put all your money into it. If your worried about a total economic collapse and breakdown of society, then you should consider storable foods, shelter and stocking up on items which can be used in barter and of course personal safety protection like a firearm.

Rianne
Rianne

These advertisements about gold is one big red flag, because we all know if it's actually selling people are simply to greedy to share it=)

Len S
Len S

I started buying GLD six years ago and bought over a period of the next two years. While I didn't get in at the $250 level, my break is $700. Since I've seen a significant profit so far I've taken incrementalgains on portions of the investment to ensure I don't get caught in a sudden down draft. Currently, I have about 25% of my investable assets in GLD and hold it solely in an IRA. Being nervous about the recent meteoric rise in GLD, I've bought out-of-the-money puts for downside protection.
I expect to hold GLD until it goes exponential...just like I saw it do in 1980 when I didn't have any money to invest!
I firmly believe there are sound reasons to own gold (destruction of fiat currencies,etc.) but I aim to profit on the "bubble" that is gold today.
After that, I'll move on to the next bubble asset.
Keep in mind though, that I have a high tolerance for risk and volatility and am willing to assume the counter-party risk inherent in GLD. My investing style is more to look at macro trends. What that means is that I'm early into an asset and can have dead money tied up for a "long" time until the market catches up.
Cheers.

Michelle
Michelle

The best time in recent years to have opened a position in gold was about 10 years ago when gold was trading for $250 an ounce.

While selling an existing position in gold might not be a prudent immediate move, I'd hesitate to open a new position at this time. There is an obvious bubble forming here and it will pop eventually like any other.

allthatglitters
allthatglitters

Gotta de-bunk some of this article (apologies if this gets long!):

First off, yes, the people who chase returns -- of anything, be it stocks, real estate, or gold -- will pretty much always get burned. They come to the party too late and most likely have no idea WHAT they are buying or WHY they are buying it (beyond just wanting a piece of the now-historical double-digit gains).

The reason I buy (buy being a misnomer) gold and silver is for wealth preservation. I don't "buy" these precious metals, per se; what I am doing is trading my inflation-riddled government fiat currency for a close-to-currency (and once was currency) replacement.
"Over the long term gold has typically just barely edged out the rate of inflation." which is exactly why you trade a portion of your cash holding for gold. For the past one hundred years, over any 20-year period, the per annum gain of gold is 5.25% (any 5-year gain is 6.2% per annum). What is your 5-year GIC or "high yield" savings account paying you?

Remember, you also pay bank fees (every YEAR) and tax on any interest (plus any brokerage fees incurred buying and selling stocks -- there are no premiums selling gold). Cash still sounding like a good idea?

$1000 in gold today will most likely purchase $1000 worth of good in 25 years. $1000 in cash today will most definitely NOT purchase $1000 worth of goods in even ONE year let alone 25 years!

If people are looking for a quick buck, gold is not the way to go.
If they are looking for a cash substitute which will not loose value compared to their cash, gold is excellent. Buy gold when "official" inflation rates are low (historically, rates are incredibly low right now), sell when rates are high.

The author states "Gold can only sit there and wait for the global market to dictate its value." The same applies, 100%, to any and all stock markets (and economies). Recall 2008 if you will. Although that crash was proliferated by fraud and manipulation, the "global market" swiftly and deftly priced in value corrections. The gold market suffers none of the same fraud or manipulation. With gold, what you see is what you get.

Another stated myth in the article is "Lack of liquidity". Dear author, are you kidding? Cash has ultimate liquidity; next is gold. Somewhere down the line is paper equities. Equities are far, far, less liquid than you think, and exceptionally less than gold. Remember, it's not the equity itself which dictates liquidity, it's the market. The market for gold has been around for millenia.

You can very definitely sell your gold with the click of a mouse -- ever hear of ebay?

Think of a trip to the local coin store as a trip to the bank -- a different type of bank.

"A bag of gold coins worth $5000" is about FOUR coins. A heavy burden indeed.

Safety deposit box yearly cost is tax deductible.
Mutual fund management fees (which erodes any profit) are not.

"...ETFs that track gold so you can eliminate the burdens of owning physical gold and maintain liquidity." -- then you do NOT own gold, you own yet another paper equity, subject to everything all your other paper equities are subject to. PHYSICAL gold removes your slice of wealth from that market. As mentioned before, there is NO "burden" to owning physical gold.

If you are still wondering if you should buy SOME gold (do NOT sink everything you have into just one asset class!), take a look at all the countries around the world whose governments hold gold reserves. Take the advice of one blogger, or heed the actions of reality.

Thanks for the time and space.

Andrew
Andrew

My two cents are that while gold is a fairly safe investment, it is still risky and there is still volatility here. Just because gold has an inherent value does not mean this value cannot change just like a company's stock can. I think there is definitely room in anyone's portfolio for precious metals but I don't think you want to overallocate. Personally, I'm scared to invest in gold right now because of how high it has risen, but then again, I'll be eating my words if gold reaches $2,000 by the end of the year! Great analysis overall in this post!

Jeremy
Jeremy

That's an interesting take, Aaron. That reminds me of the TV show Meteorite Men. They are a couple of guys who use their smarts to go out and hunt for meteorites from space and sometimes just add them to their collection or even turn around and sell them. It's kind of amazing how an ugly little "rock" can turn out to be worth hundreds, if not thousands of dollars.

Aaron McCulloch
Aaron McCulloch

While I do not believe an "investment" in gold is any safer than any other investment, I do believe that having gold is a good move, and the best way to do that is to go get it. Put down that phone to "goldline", and pick up a geology book and a few USGS maps...go get it. You could do a lot worse for a hobby. Its great excercise, there is plenty of gold out there, and the hobby is full of great people. Gold in nugget form is often worth more on the gem collector market than its market weight. You will not get rich prospecting, but there are very few other ways to get a camping trip in and bring home a few hundred bucks on the same weekend! I've also started a bit of a cottage industry "testing" gold wieght and purity for folks getting ready to send in one of those envelopes...just so they know what they have. There is money to be made from gold, just maybe not in the "rush" of 2010.

christine nielsen
christine nielsen

I ended up taking half of my retirenent and put it into gold. So 15,000 stayed in american funds "stocks & bonds" now I have over 18,000 in that. Another 15,000 went into gold and that has alittle over 12,000. Should I put the money i invested in gold back with the stocks and bond?

James
James

to my understanding you can buy gold just like a stock you might not see the stock certificate but you have documentation saying that you own the stock.

Similar with gold i don't know anyone who has gold bars at their house. but i do know people with gold chains and the option of gold.

Credit Girl
Credit Girl

Haha I saw the gold machine thing in Dubai! Kinda funny.. I personally wouldn't use it. Anyway, there are so many different sides to gold and I can see both sides. Im still debating which side to take though.

Lorne Canada
Lorne Canada

Finally somebody said it loud! I can't stand this gold frenzy, it seems even our garbage man is going to invest into gold. It was the same with real estate - people started to believe property prices never would go down...
Gold went high several times (inflation adjusted record is $2500 in 1980...) and always returned back to somewhere around $300-$600. On the other hand, who knows what the recent monetary madness will do to inflation...

Jacob Harding
Jacob Harding

Smart investors (i.e. prudent people) wouldn't divulge information like "I have gold bars in my house!". If they do they better sleep with one eye open. :)

Jeremy
Jeremy

That's true, but it's amazing how fast information can spread even if you aren't divulging information like that. You may casually mention to your friend over a game of golf how you've started investing in physical gold, not even mentioning you keep the bullion in a lockbox in the house. But who knows, your friend mentions how he got the gold idea from you to another friend, who mentions to another friend, and somehow a person who doesn't exactly live up to the same moral standards as the rest of us hears about it and before you know it your home is broken into.

Heck, even if you don't store the gold at home and at the bank or something it could still somehow get around town as a rumor and end up having someone break in just assuming the gold is in the home.

Of course, this goes for any valuable asset. If you're bragging about the new car stereo system or high-end home entertainment theater and the wrong person catches wind of it it's the same sort of problem.