Personal finance: Understand the nuances of investing in gold
April 7, 2024
Gold has been a symbol of wealth and stability for centuries, and it continues to be a go-to investment for those seeking stability in uncertain economic times. But investors need to understand the nuances involved in owning gold – such as knowing the real benefits, how physical gold compares to gold stocks, and the truth about its effectiveness against inflation. It's also important for anyone considering gold to think about the timing of their investment and how it complements their broader financial portfolio.
Here's a little historical context
In 1934, President Franklin D. Roosevelt signed the Gold Reserve Act into law. This legislation centralized all monetary gold ownership with the U.S. Treasury and ended the practice of redeeming U.S. dollars for gold in domestic transactions. Its goal was to stabilize the economy during the Great Depression by giving the government more control over the monetary supply. Critics, however, argued it limited personal and institutional gold ownership – fundamentally altering the U.S. monetary system in the process.
This prohibition on private gold ownership was lifted when President Ford signed a bill repealing the relevant sections of the Gold Reserve Act. This legislation, which took effect on December 31, 1974, allowed U.S. citizens to own gold bullion without any restrictions. (Before this repeal, Americans could own gold coins, but restrictions were in place for gold bullion.)
Why investors turn to gold in uncertain times
Gold is often seen as a reliable investment when the economy or the stock market is not doing well. This perception of gold as a safe haven is rooted in its historical stability, which investors find attractive when the future looks unpredictable. Recent global events, like ongoing elections, continuing conflicts in regions like Ukraine and Israel/Palestine, and economic upheavals, have created a sense of uncertainty that's driving some investors to take a closer look at gold.
But deciding when to invest in gold and when to sell can be tricky. While gold can be a safe choice when other investments are falling, it usually grows less than stocks and bonds over the long term. The challenge for investors is figuring out when to move their money out of gold and into these other investments. This decision is difficult because it's hard to predict how long the uncertainty will last or when the stock market will start to recover. Investors need to weigh the comparative safety of gold against the potential for higher returns from other investments.
Physical gold vs. gold stocks
Many people don’t realize there’s a significant difference between owning physical gold and investing in gold stocks. Physical gold means having actual gold items, such as bars and coins. While these represent a tangible investment that some investors find attractive, they also come with the need for secure storage and finding a trustworthy seller. On the other hand, gold stocks represent investments in companies that mine or trade gold. They don't involve owning gold in its physical form.
The main advantage of gold stocks is their liquidity. They are much easier to buy and sell than physical gold, making them a more convenient option for investors looking to quickly move in and out of their positions. Also, there's no need for storage or insurance as gold stocks can be held in a standard brokerage account, which simplifies the investment process.
Investors need to understand these differences before making a decision. Each option has its pros and cons, so it's crucial to carefully evaluate your investment goals and risk tolerance when choosing between physical gold and gold stocks.
Can gold protect against inflation?
Many investors believe that buying gold can protect their wealth against inflation, a notion largely rooted in the 1970s when gold prices shot up during a period of high inflation. But gold's effectiveness as an inflation hedge isn't as straightforward as it seems since it requires investors to accurately predict when to sell. While it's true gold returned 35% from 1973 to 1979, those who missed the peak lost an average of 10% from 1980 to 1984.
In comparison, other investment vehicles such as stocks, bonds, and real estate have historically offered more consistent protection against inflation. These assets can provide returns that outpace inflation over time, whereas gold’s performance can be more volatile and dependent on market timing. While gold may have its place in a diversified investment portfolio, relying solely on it for inflation protection might not be the best approach.
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Incorporating gold into your investing strategy requires a nuanced understanding and careful approach. While its historical appeal during economic downturns and uncertainty is clear, investors should weigh gold against other investment options, especially as protection against inflation. Other assets like stocks, bonds, and real estate might offer better returns over time.
The decision to invest in gold, either directly or through gold stocks, should be made with a clear understanding of one’s investment goals and risk tolerance. Gold can play a valuable role in diversifying a portfolio, but its effectiveness hinges on thoughtful timing and integration with your overall investment strategy.
Jennifer Pagliara, CFP, CTFA, is an executive vice president and financial adviser at CapWealth.
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