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.