Why buy gold?
Many professional and retail investors view investments in gold as a hedge against risks in the financial system. Two major recessions have occurred in just the last decade: first, the bursting of the new economy bubble and later the mortgage scandal followed by a global financial and later an economic crisis. The still ongoing financial and economic crisis and the government responses have led to a strong increase in government debt in most developed countries like the US and the UK. For that reason, the economic and financial crisis has over the last several months developed into a sovereign debt crisis.
Recognising this, many investors now try to protect their wealth or parts of it by investing in assets which are less dependent on the stability of the financial system. Gold is one asset class, which is perceived as a store of value in the long term.
Gold is a unique asset class (read article on Gold as an investment on Wikipedia). Gold investments have historically shown a low correlation with investments in other asset classes such as stocks or shares, mutual funds, government and corporate bonds and even commodities and other precious metals.
Investing in gold can help to preserve value by reducing the risk of severe losses. The relative independence of gold investments from other asset classes makes investing in gold an attractive strategy for diversifying an investment portfolio. Portfolio diversification is a pillar of risk reduction. The probability of one asset class or a single investment significantly dropping in value is far higher than the chances that a well balanced portfolio of many different investments from various asset classes will depreciate in value significantly.
Over the last decade, gold investments were one of the best performing asset classes. In nominal terms, the price of gold has risen from below 300 US-Dollars to above 1,500 US-Dollars. In contrast to paper currencies like the US-Dollar, the British Pound or the Euro, gold is a limited resource. Gold cannot be inflated. For this reason, gold has historically remained a relatively stable purchasing power, whereas practically all currencies have lost purchasing power in the long run.
The characteristic of gold to retain its value makes gold investments attractive for retirement and pension purposes. Over the past years, gold has gained in popularity as a retirement asset.
What amount to invest in gold?
Investors who decide to put a share of their savings or investments into gold face the question of how much to invest in gold. Choosing the ideal portion of a portfolio to allocate to gold is key in creating a well-diversified portfolio which minimizes investment risks.
Expert recommendations range from below 5% to well over 15%.
How to invest in gold?
Investments in gold can be done in various ways:
- Gold-backed securities like Exchange Traded Funds (ETFs) or physical gold funds
- Non-gold backed securities such as gold index funds (index trackers)
- Physical gold
- Other forms of gold investments like gold certificates, gold accounts or gold trusts
The decision on the type of the gold investment should be based on an assessment of each option with regard to safety and cost aspects. In our opinion, there are several arguments in favor of physical gold.
Physical gold allows direct ownership of gold with no barriers between the investor and his/her gold investment. A default on the part of the provider does not impact the investor’s real ownership of the gold. The gold is the legal property of the investor.
Vaulted gold, i.e. professionally stored physical gold, is a product that private banks have traditionally offered to wealthy investors. Today, vaulted gold is also offered to retail investors. The advantages of this form of physical gold investment are its high liquidity, its ease of handling, the relatively low costs and its safety.
Depending on the provider, vaulted gold can be bought and sold easily, 24 hours a day, 7 days a week, 365 days a year. In most cases, costs for buying or selling vaulted gold are significantly lower than buying small gold coins or gold bars. The regular costs for insured safekeeping of gold are also low. Depending on the investment amount and product provider they can be significantly lower than the regular management costs for a gold fund or even a gold ETF.
Costs of gold investments
The costs of a gold investment depend very heavily on the specific type of investment and on the specific provider of the product. From an investor’s standpoint, the costs can be categorized as one of the following:
- Costs for buying gold / gold investments
- Regular costs for administration / safekeeping of the gold investment
- Costs for selling a gold investment
Risks of gold investments
As with every investment, investing in gold may also carry risks for the investor. The price risk, i.e. the likelihood that the gold investment will drop in value due to a decrease of the gold price, is the most obvious risk of a gold investment. Private investors should only invest a limited share of their overall portfolio in gold. Diversification generally reduces the risk to the overall investment portfolio in case of price movements in individual asset classes.
Other risks of gold investments could be counterparty risks or liquidity risks. Investors are advised to check the product characteristics (e.g. outright ownership of gold and custody by an independent third party) and the product providers (e.g. trustworthiness) before investing any money.
If investors invest in financial products which are linked to the price of gold, they usually face the counter party risk. If the issuer of the financial product becomes insolvent, the investor may lose money.
Tax on gold investments
Disclaimer: The information contained herein is general in nature and is not intended as legal, tax or investment advice. The information contained herein should not be used in any actual transaction without the advice and guidance of a professional Tax Advisor who is familiar with all the relevant facts.
Bullion gold is VAT exempted in the European Union as well as in the US and other countries.
The taxation of capital gains from gold investments depends on your country’s tax codes and the form of investment. In the US and UK investors have to declare capital gains from gold investments and pay a tax on the gains. In the US, there is in general no difference in capital gains tax on physical, vaulted gold, gold ETF or other gold-backed securities.