Investing in gold has long been a strategy for those looking to diversify their investment portfolios and hedge against economic uncertainty. Whether to hold physical gold or invest in gold exchange-traded funds requires examining the trade-offs with each, including their liquidity, costs, returns, risks, and the practicalities involved. In general, gold ETFs offer some tax advantages and lower costs over time than trading physical gold. Below, we will guide you through your options for each, giving you a better sense of which, if either, works best for your portfolio.

Physical Gold

Physical gold can be bought in several ways, and gold mines are found in more places than is typical for other commodities. The largest producers of gold are Australia, Canada, China, South Africa, and the U.S. Gold jewelry is sold worldwide in retail stores and the secondhand market. The quality or purity of the gold in such items is measured in karats (or 1/24th parts). According to the U.S. Geological Survey, in 2023, gold jewelry accounted for about 43% of the market for the metal. Physical bars or bullion made up about 16%, with another 9% going into gold coins.

You can buy gold from government mints, dealers, private collectors, pawn shops, and so on. The price you pay depends on how much gold is valued at the time, as well as the purity of gold in the bar, coin, or jewelry. The price of gold as of Feb. 14, 2024, is $1,993.32 per ounce. That's down from its all-time nominal high in December 2023 ($2,135 an ounce), which is lower than its inflation-adjusted record in January 1980 (about $2,636 in February 2024 dollars).

Coins and jewelry tend to sell for a premium over the quoted price of gold. How much depends on the manufacturer or origin. Gold bullion is often sold by gram and ounce and its purity should be stamped on the face of the bar. Gold coins are generally available in quantities of one ounce or less.

An important thing to remember when buying physical gold is that you’ll need somewhere safe to store it and get it insured. You'll also want to ensure you're getting what you pay for. This area of investing is notorious for scams involving gold mines that don't exist, gold bars that are not all gold, and the like. The Commodities Futures Trading Commission, taking no chance at burying the lede in its summary, titles its memo on this commodity "Gold Is No Safe Investment." Buy only from reputable dealers and have your gold appraised before buying. This adds to your costs, but it also gives you peace of mind.

Gold ETFs

Gold exchange-traded funds (ETFs) expose investors to gold price moves without having to buy the physical underlying asset. Gold ETFs are typically structured as trusts. These funds hold a certain number of gold bars for each share of the ETF issued. Buying a share of the ETF means owning a part of the gold held by the trust.

Because these ETFs hold physical gold, their prices move with the price of gold over the short and long term. However, minor tracking errors sometimes occur when the ETF price deviates from its reference asset. When tracking errors occur, arbitrageurs quickly step in.

There are many gold ETFs. We will consider two of the most popular choices.

SPDR Gold Shares (GLD)

The SPDR Gold Shares ETF (GLD) is one of the largest gold ETFs. As of Feb. 9, 2024, the fund held about 27 million ounces in its various vaults for a net asset value (NAV) of about $55 billion. Each share of the ETF was worth about 0.093 ounces of gold.

As the price of actual gold changes, so does the price of GLD. Investors may push the price above or below NAV, meaning individual shares may not be worth exactly 0.093 ounces of gold.

At the fund's inception, shares were worth one-tenth the price of gold. The amount of gold represented by each share is slightly eroded over time as the ETF charges investors a 0.4% annual fee. These fees slowly lower the NAV of the ETF, thus slightly reducing the amount of gold that a share is worth each year.

This fee is relatively low given the costs of storing and insuring it yourself. According to the World Gold Council, gold returned an average of 7.78% per year between 1971 and 2022. Physical gold storage and insurance fees for small investors are usually higher than 0.4% per year. Therefore, gold ETFs are an efficient vehicle for investing in gold.

iShares Gold Trust (IAU)

Another popular choice for gold investors is the iShares Gold Trust (IAU) from BlackRock. Like SPDR Gold Shares, the iShares Gold Trust is organized as a trust, holding physical gold bars in vaults in London and New York.

As of Feb. 9, 2024, the ETF held over 12.6 million ounces for an NAV of $25.5 billion. With 666 million shares outstanding, each share represented about 0.019 ounces of gold. This will erode over time, as the fund has an expense ratio of 0.25%.

Leveraged and Inverse Gold ETNs

Leveraged and inverse gold funds are also available. These are more complex than ETFs because they do not physically hold the asset in trust. Instead, leveraged and inverse funds usually trade as exchange-traded notes (ETNs), which are debt obligations of the ETN's underwriter.

The price of the ETN tracks a commodity index. However, an ETN depends on the creditworthiness of the underwriter, and investors aren't buying a stake in the gold that's held. Leveraged and inverse gold ETNs are intended only for short-term trades. They track gold's daily moves, not the long-term changes. The use of leverage can magnify losses from volatility. Inverse gold funds have negative expected returns in the long run because gold prices generally rise in a fiat money system. Below are two of these ETNs.

ProShares Ultra Gold (UGL)

The ProShares Ultra Gold ETN (UGL) aims to provide twice the daily return of the Bloomberg Gold Subindex, a rolling index that tracks gold as measured by the price of COMEX gold futures contracts. The ETN's leverage and daily reset feature make it suitable only for shorter-term traders. It has an expense ratio of 0.95%.

DB Gold Double Short ETN (DZZ)

The DB Gold Double Short ETN (DZZ) moves inversely to gold prices. If gold moves up 1% on the day, DZZ should drop by 2% because it moves twice as much in the opposite direction. The notes are thinly traded, and the expense ratio is 0.75%. Deutsche Bank launched the ETN in 2008. In 2016, it stopped issuing further notes. However, investors can still buy and sell shares on the market. The suspension of new issuances can affect the ETN's liquidity and potentially its price, as the supply of shares in the market is fixed and no longer adjusts in response to demand.

Key Differences Between Physical Gold and Gold Funds

The most notable difference between physical gold and gold funds is that with the former, you have possession of gold. With funds, you are investing in gold, but somebody else holds it on your behalf. This direct ownership lets you physically handle and securely store your gold, granting you complete control without concerns about tracking errors or the broader market’s fluctuations.

Investing in gold funds means your investment is in gold indirectly, with the physical asset held and managed by professionals on your behalf. This method of investing is typically more efficient for several reasons:

• Easy to trade: Buying and selling shares in gold funds can be done quickly online without the physical handling, storage, and security concerns.
• No storage worries: Like romance movies don’t show you how they live happily ever after, so, too, old stories about finding a treasure chest of gold don’t go into the detail of the logical hassles of securing and insuring the metal. Investors don’t need to secure storage or insure the physical gold when investing in these funds.
• Professional management: The investment is overseen by experts who manage the fund, making informed decisions on behalf of investors, which can be particularly beneficial for those less familiar with the gold market.
• Lower costs: While gold funds incur expense ratios, these fees are generally lower than the combined costs of buying, storing, and insuring physical gold, making it usually more cost-effective.

This approach simplifies investing in gold and can be more accessible for individuals looking to include gold in their investment portfolios without the complexities of handling physical gold.

The Bottom Line

There are differences between investing in physical gold and gold ETFs that go beyond one being physical metal and the other being tradable shares. Nevertheless, a major advantage of gold funds is their generally higher liquidity because they can be bought and sold instantly on the stock market during trading hours. In contrast, selling physical gold requires finding a buyer and may involve authentication processes, which can take longer. Inverse and leveraged ETNs are more complex than gold ETFs. They track daily gold price changes by going in the opposite direction or magnifying price moves. Leveraged and inverse ETNs are not meant to track long-term gold price changes. While the expense ratio of ETFs can erode the amount of gold each share represents, they are often more cost-effective than buying and storing physical gold.