The phrase “invest in gold” is a bit of a misnomer. When you put your money into an investment, you do so with the expectation (and hope!) that it will grow or produce more money through dividends or interest payments. This is a core principle of investing. Unlike more traditional investments like equities, fixed income, or real estate, gold doesn’t produce anything and it doesn’t pay dividends. When you invest in the common stock of a large company, typically that company produces some level of profit. Depending on the strategies employed by senior management, growing firm profits can result in share price appreciation or even some level of capital returned back to shareholders via dividend payments or share buyback programs. Holding stocks represents partial ownership of the company. As the business performs well, so does your equity investment. Similarly, real estate investments can generate rental income; when you purchase a bond, it typically pays interest. Gold, on the other hand, does none of these things.
Does Warren Buffett recommend investing in gold?
Legendary investor Warren Buffett is not a fan of gold as an investment. In his 2011 letter to Berkshire Hathaway shareholders, he explains why: “Gold … has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.” Buffett does not consider gold to have a specific use, and therefore he does not ascribe much value to the glittery metal. It’s worth noting that he feels the same way about bitcoin as an investment. At the 2022 Berkshire Hathaway annual shareholders meeting, he claimed he wouldn’t buy all the bitcoin in the world if someone offered it to him for $25 because the digital currency, “isn’t going to do anything.”
We know that an ounce of gold doesn’t get any heavier as it ages, but does its value grow as the years pass by? In his oft-cited book, Stocks for the Long Run, Jeremy Siegel shows the inflation-adjusted returns across various asset classes during the period 1802-2012. Gold significantly underperformed vs. stocks, bonds, and Treasury Bills. One dollar of Treasury bills purchased in 1802 would have grown to $282 by the end of 2011; a dollar in long-term bonds would have been worth $1,632. One dollar uninvested would have lost most of its value during that time period due to inflation, ending up worth just 5.2 cents. A dollar put into gold would have grown to $4.50. That does make gold a better choice than holding cash during this time period, but that is a pretty abysmal return. On the other hand, if you had invested one dollar into a basket of stocks reflecting the overall equities market in 1802, that dollar would have turned into an incredible $706,199 by 2012. Granted, most people do not have an investing horizon spanning multiple centuries, so this kind of performance is not a realistic expectation, but you can clearly see the potential opportunity cost of missing out on equity market returns.
Since gold has no cash flows, yields, P/E ratios, or any other quantifiable intrinsic value, the valuation of gold is tricky. Unlike other investments, no one stands behind the price of gold—no corporation or government entity. In a capitalist economy, at any given time, an item is only as valuable as the price someone else is willing to pay for it. Admittedly, gold has some worth related to its use in jewelry and electronics, but the primary reason it is valuable is that we all agree that it is.
Are gold prices volatile?
Gold prices tend to rise in times of market uncertainty when investors are worried about the economic outlook or geopolitical shocks, helping to offset possible declines in stocks. The price of gold is impacted by unforeseen, uncontrollable forces, including the ebb and flow of demand for other investments. As a result, gold prices are volatile, riding waves of emotion, particularly fear. If people lose faith in gold’s function as a store of value, its price will decline. Thus, ironically, the greatest risk to gold’s value is a loss of faith that gold will continue to maintain its value. If no one acknowledges gold as a store of value, it has none. However, gold has held this position pretty firmly for a few thousand years, so it seems unlikely that it will spontaneously fall apart.
Since gold doesn’t produce anything or pay any dividends, it’s difficult to value, and you can’t reasonably expect it to appreciate over time, are there any good reasons to buy gold? Gold is commonly described as a safe haven investment. Warren Buffett asserts, “Basically gold is a way of going long on fear, and it’s been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in the year or two years than they are now.”
Is gold a reliable store of value?
As mentioned above, people tend to flock to it in times of crisis or uncertainty in order to feel more secure and balance out other areas of their portfolios. Many people in the investment community consider gold to be a reliable store of value that can serve as a hedge against inflation or insurance against a decline in value of the major currencies. (However, gold has a pretty spotty record as a store of value. For example, in 1980, gold prices peaked and took another 27 years to hit that level again.) People perceive that the supply of gold is finite and find comfort in the fact that it is difficult for a central bank to debase it. This does not mean it cannot be devalued in other ways; mining companies can increase the supply of gold, and do so quickly if the price rises. Furthermore, during the period of decades high inflation in 2022, the actions of the hawkish U.S. central bank quickly strengthened the value of the U.S. dollar, which put downward pressure on gold bullion prices (the exact opposite of what gold bugs would traditionally hope for in times of such economic uncertainty and rampant inflation).
Should I buy gold in case of emergency?
Gold advocates argue that the point of gold isn’t what it can produce; rather, its value comes from the fact that it acts as a source of protection in times of crisis. Just because you don’t always need to use your emergency fire extinguisher doesn’t mean that you shouldn’t have one. In some rare cases, that fire extinguisher could save your life, so you keep one under your sink just in case your house starts burning. Similarly, when inflation soars, extreme market volatility rears its ugly head, or geopolitical tensions flare up, you don’t look to invest in penny stocks—you buy gold instead…maybe.
Investing in gold may be right for people who believe that we are enduring a crisis or long-term period of uncertainty, e.g. a currency crisis, a period of hyperinflation, or an era of general distrust in the banking system. In times like those, gold may indeed serve as a safe haven for investors. Jeremy Siegel notes, “There isn’t anything that’s clearly better [than gold] if you’re concerned about those sorts of events.” But he also comments that people who typically run to gold tend to be “overly concerned” about catastrophe in the first place. Admittedly, these crisis situations can be difficult to define. Aren’t all investing time periods marked by uncertainty? If that’s the case, you might argue that there should always be a place for gold in your portfolio, just as there should always be a fire extinguisher under your kitchen sink.
Should I buy gold for a market apocalypse?
If you believe that the entire economic system is on the verge of collapse, gold might be a good investment for you. When you put a large portion of your wealth into gold, you are essentially sitting out of the market waiting for an unlikely event to happen, while more traditional investments are producing better returns, at least in the long-term. Well-known RIA industry blogger Michael Kitces asks potential gold bugs, “how much of a bet do you want to make on this world-economic-meltdown-disaster system? [If you put all your money into gold] and the world doesn't end, and the darn system just keeps chugging along and growing, are you actually going to ruin your goals in the normal scenario because you bet on the end of the world and the world didn't end?” On the flip side, if the investor thinks the inevitability of the entire economic collapse is merely a temporary thing (as in, ‘I just want to wait until things settle.’), that's a market-timing discussion.
How much gold should be in my portfolio?
Gold can do well in crises—just when most other investments do poorly. Similarly, gold often does worst in good times when other investments do well. This means that gold can stabilize your portfolio or reduce its risk in turbulent times. But you should still limit your holdings of gold given its drawbacks. According to Forbes, most advisors recommend you allocate no more than 10% of your portfolio to gold. At One Day In July, we don’t typically recommend holding any gold directly in our client’s investment accounts (although there is some intrinsic exposure to gold mining firms in index funds linked to the S&P 500). As Siegel’s data show, stocks have a good long-term track record against inflation. This is because companies can increase their prices as inflation drives up costs of materials and labor. Inflation can also lift customers’ incomes, enabling them to pay higher prices. A well-diversified investment portfolio in general can help guard against inflation.
Should you decide that having some gold in your portfolio is right for you, there are many different ways to add it, each with its own unique characteristics and varying tax implications.
How do I buy physical gold?
One option is to buy physical gold in the form of bullion, coins, or jewelry. This comes with logistical hassles and security risks. You may need to pay for delivery and storage (a safe deposit box or space at a vault) and obtain insurance for your gold, both of which can be difficult and expensive. You may also have risk in shipping. Physical gold is generally purchased from dealers outside of traditional brokerages. Be sure you are working with a reputable dealer or you risk being scammed. Gold jewelry in particular carries additional investing risks. Jewelry may not be pure gold, and you’ll likely pay a premium over the raw value of the gold based on the jewelry’s designer or manufacturer. When it comes to gold jewelry, authenticity and purity matter for resale purposes. Only buy investment jewelry from a reputable dealer and be sure to get appropriate documentation.
How is gold taxed?
Keep in mind that physical gold is taxed at the collectibles capital gains rate. For short-term assets, this is equal to your marginal tax rate. For long-term assets, however, the collectibles capital gains tax is your marginal tax rate up to a maximum of 28%. This is a potential disadvantage over more traditional investments where long-term capital gains are generally taxed at a lower rate than your marginal rate.
If you are interested in having some exposure to gold in your portfolio, but you are wary of the unique risks and inconveniences that come with purchasing physical gold, consider buying stock in gold mining companies. As an investment, this is a much more straightforward approach than buying physical gold. Gold mining stocks can be purchased in a regular brokerage account. Their share prices are impacted not only by the price of gold, but, like other common stocks, are also related to the underlying company’s fundamentals (profits, expenses, etc.). This helps make the decision to invest easier to analyze compared to the considerations for buying physical gold. Because of their connection to a particular business, gold mining stocks carry similar risks to investing in any other single stock, including price volatility and lack of diversification. For taxes, shares of gold mining companies are treated like other stocks, not as collectibles; long-term gains are subject to standard 20% maximum federal rate; short-term gains face a maximum rate of 39.6%. Higher income investors could also be hit with 3.8% net investment income tax and state income tax.
Are there gold ETFs?
There are also various gold exchange-traded funds (ETFs) and gold mutual funds. Like most funds, these investments provide more diversification than individual gold stocks, and they typically offer more liquidity than physical gold. There are a range of different types of gold funds, and they may or may not hold actual gold. Some gold ETFs track the price of physical bullion, while others track an underlying basket of stocks of gold mining and refining companies. Like stock in a gold mining company, the value of gold mutual funds and ETFs may not entirely match up with the market price of gold. Keep in mind that investment returns for any ETF or mutual fund will be diminished by the fund’s expense ratio. It’s also important to note that long-term gains from selling gold ETF shares are subject to a 28% maximum federal income tax (taxed as a collectible), just like physical gold. Short-term gains are subject to a maximum federal tax rate of 39.6%. Similar to gold stocks, gains may also be subject to 3.8% net investment income tax and a state income tax.
Speculation with Gold Futures and Options
The riskiest way to invest in gold is by trading gold futures or options, which is considered a form of speculative investing. As derivatives, their values are based entirely on the price of the underlying asset, and, remember, those gold prices are volatile and notoriously difficult to predict. You can typically trade gold futures yourself in a brokerage account, or you can purchase an ETF that does the trading for you. Gold futures are taxed very differently from other investments and they aren’t considered direct ownership of gold. Gold futures ETFs are taxed in the same manner as individual futures. Any gains or losses realized by selling these types of investments are treated as 60% long-term gains (up to 23.8% tax rate) and 40% short-term gains (up to 40.8% tax rate), regardless of how long the investor has held the ETF.
What are gold exchange-traded Notes?
Finally, you can buy exchange-traded notes (ETNs) whose return is linked to the price of gold bullion or to a particular gold index. An ETN is a bit like a bond, in that when the note matures, the issuer pays the investor the initial investment plus or minus the return of the associated index, changes in the spot price of an asset, or some other specified benchmark. Some ETNs pay the inverse of the underlying asset’s return. Like a stock or ETF, ETNs can be conveniently traded on an exchange. Commodity ETNs are generally taxed much like equity and bond ETNs, with long-term gains taxed up to 23.8% and short-term up to 40.8%, the ordinary federal rate.
Before you make any investment, you should understand the risks, tax implications, and other potential costs of holding the asset. When it comes to gold, the Midas touch cannot be guaranteed.
Sources:
https://www.berkshirehathaway.com/letters/2011ltr.pdf
https://moneywise.com/investing/stocks/warren-buffett-just-said-he-doesnt-own-bitcoin
https://knowledge.wharton.upenn.edu/article/investing-in-gold-does-it-stack-up/
https://www.wsj.com/articles/why-gold-prices-high-warren-buffet-11597691966?mod=article_inline
https://www.kitces.com/blog/is-there-any-value-in-investing-in-gold/
https://www.cnbc.com/2011/03/02/cnbc-buffett-transcript-part-2-the-zebra-that-got-away.html
https://www.advisorperspectives.com/articles/2022/09/21/top-gold-ceos-say-soaring-costs-will-hobble-mining-industry-into-2023
https://investorplace.com/2020/06/warren-buffett-is-a-legend-but-hes-wrong-about-gold/
https://www.kitces.com/blog/talking-clients-out-of-the-bunker-portfolio/
https://www.forbes.com/advisor/investing/how-to-invest-in-gold/
https://money.usnews.com/investing/investing-101/slideshows/things-to-know-before-you-invest-in-gold?slide=4
https://investingnews.com/daily/resource-investing/precious-metals-investing/gold-investing/tax-on-gold-silver-investments/
https://www.forbes.com/sites/bobcarlson/2020/09/19/dont-let-taxes-slash-your-gold-profits/?sh=3140518e6530
https://www.schwab.com/learn/story/etfs-and-taxes-what-you-need-to-know
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