Gold is commonly considered an investment that combats inflation and the US dollar to mitigate risk and protect long term wealth. Gold has become a safe haven to many investors in times of economic uncertainty as an alternative to the stock market. In recent news, with the UK voting to leave the EU, gold prices surged as the future of the British deemed unpredictable.
While Gold is a great investment for these reasons, there are a few things to consider before you make the decision. In this article, we will be looking at considering the risk tolerance, time horizon and variety of options available.
Risk Tolerance of Buying Gold Stock: High or Low?
Depending on your risk level, there are multiple choices that are available to purchase gold. Let’s start by looking at the “high-risk, high-reward” investor. If you are someone who has a large appetite for risk, there are a number of investments at your disposal. Let’s look at some of the mistakes that these types of investors may fall into.
Recently, there has been a lot of buzz around gold penny stocks and stories of people making millions trading them. What you may not hear is that 9 out of 10 investors lose money investing in penny stocks. These stocks tend to be highly volatile and illiquid. This means that prices could rise 50% in one day or go to $0 in a moment’s notice based on one bad press release. Along with this, a big misconception that investors have is the ability to freely buy and sell these types of stocks at any time. For every buyer, there must be a seller.
I have personally been in a situation where I got into a penny stock, was up 40% and COULD NOT SELL! The reason? There were no buyers at the time that I wanted to sell. That was the moment I realized that I was sucked into a pump-and-dump scheme. Everyone was buying, until there were no more buyers available. I watched as 3 days’ worth of gains to get to 40% unrealized profit, turned into a 25% loss in a matter of a few hours simply because there were no sellers willing to take my shares.
Make sure the spread (the difference between the bid and ask) is very small and that there is enough volume to get in AND out of a trade when possible. Personally, I have learned my lesson from this experience and have decided to stay away from penny stocks as a whole (I recommend you to do the same).
Some other options available include leveraged ETFs (Exchange Traded Funds) or ETNs (Exchange Traded Notes) as well as derivatives like futures and options. All these choices provide some form of leveraged return to gold price movements. While this is great when profitable, it is as harmful when you’re in the red. For example, a leveraged ETF like UGLD provides 3x the impact as gold prices change. If gold prices fall 5%, that means UGLD will fall 15%.
Similar leveraged returns can be experienced through derivatives like futures contracts and options. However, please keep in mind that these are all highly risky and a lot of research must be done before diving into these forms of investment. PLEASE know what you are getting into before putting money on the line.
If you are a low risk taker like me, your best bet is to invest in either physical gold bars or simply use non-leveraged ETFs. While buying gold bullion bars provides you with a tangible asset in your possession, there are numerous fees that come with it. On the other hand, investing in an ETF like GLD (SPDR Gold Trust) or IAU (iShares Gold Trust) are lower in transaction costs and give you the same benefit as directly owning gold. This allows investors to get as close correlation to gold prices as possible, without the costs of insurance and storage.
While the time horizon of a trade may seem completely unrelated, there are some mistakes that should be avoided. First off, you need to figure out whether this is a short term gold trade or a long term gold trade. Short term trades are usually done in a speculative nature to take advantage of some event or news. For example, Brexit was recently a great example of this idea. Investors wanting to day trade based on the decision of UK’s polls on exiting the EU would have bought or sold depending on their preferences (likely multiple times).
Did you know that trading volumes on Gold almost doubled on the day of the vote? While day trading can be lucrative, commissions/fees become a huge factor in the success or failure of your performance. Many traders do not factor in the cost of frequent trading as brokers may charge upwards of $10 per trade (that’s $10 to enter, another $10 to exit). You’d be surprised how quickly this can add up!
On the other hand, on the long term horizon, a key idea to understand is the idea of dollar-cost averaging. While you can invest a full lump sum amount of capital in one go, it is much more efficient to invest a fixed amount on a monthly basis. Dollar cost averaging essentially gives you a way to lower your average cost per share and smoothen volatility. To give you an example of why, assume you invest in a stock that is currently at $50 this month, you can buy 20 shares. Assume in another month, the price is at $100. That’s only 10 shares for $1,000.
When prices are low, you buy more shares. When prices are high, you buy less shares. With dollar cost averaging, your price per share remains as low as possible while you continue to increase your investment value in the stock, commodity, and/or ETF. The idea of dollar-cost averaging is something that many understand intuitively, but very few put into action. Avoid the mistakes of putting all your capital in one go to mitigate risk.
Stocks vs ETFs vs Mutual Funds vs Physical Gold? Which one do I pick?
With so many options available, which one is actually the right one? Well this depends on what exactly your preferences are. Below is an overview of where to buy gold stocks.
Is it really the best way to get some exposure into gold? When you invest in one single stock, you’re essentially putting all your eggs in one company’s basket. You are risking money into a COMPANY rather than GOLD. If you buy one gold mining company, it will definitely have some correlation to gold. However, what if the financials are not on par with the industry? What if the management has a hidden agenda? What if some external factor outside of gold prices affects this company specifically?
All I’m saying is, if you are going to put all your money in single stocks, do some due diligence before entering (financials, valuation, management, business structure, and strategic objectives). If your aim is to simply gain some exposure to gold, there are better ways of doing so than investing in stocks.
You cannot get more direct exposure to gold prices than to buy gold bars themselves. However, there are still ups and downs with this choice of investment. Don’t get me wrong, this is the best measure you can take when it comes to actually OWNING gold. In the event of a financial, economic, and/or political disaster, the physical ownership of gold would be better than relying on a third party to deliver the gold to you as per a promissory note (stock, ETF/ETN, futures contract).
Despite this point, since it becomes a physical object that you hold, it will result in additional fees which ultimately increase the cost of ownership in comparison to other options (storage, insurance, transaction, and markup costs).
I didn’t mention mutual funds in this post because they are very similar to ETFs. They will provide a diverse set of stocks, bonds, and/or other investment vehicles bundled up into one fund that you can invest in. However, these are usually on the higher end of fees. Look into the Management Expense Ratio of a fund to learn more about this. While most ETFs charge somewhere around 0.5% fees, hedge funds usually follow the “2 and 20” structure (2% annual fees along with 20% of your returns). Even primary funds from the big banks will charge 3-5% fees.
ETFs/ETNs are very similar to mutual funds in that they contain a basket full of investment vehicles which you can own by simply buying 1 share. These funds usually track a certain asset that they hold themselves. For example, SPY is an ETF that tracks the S&P 500 index exclusively. Like mentioned earlier, GLD or IAU are two ETFs that track the price of gold EXCLUSIVELY. Both these ETFs provide you a way to invest in gold at less than 0.5% fees. Overall, ETFs like GLD and IAU provide low costs of transaction along with accurate, direct exposure to Gold.
We have looked at some of the common mistakes investors make. We went through the various investment vehicles available for purchase dependent on your risk tolerance. We went through the time horizon of your trade and what you can do to mitigate risk. Finally, we looked at the various ways to add gold stock into your portfolio.
One last idea that I want to leave you with is the importance to pick the right broker. While you can optimize your costs of ownership by investing in a certain ETF in comparison to a mutual fund, the largest fee in order to acquire any share is you’re your brokerage. It is important to pick a broker who is trustworthy, cost-efficient, and great in customer service / communication. Make sure to perform due diligence before you put money in a brokerage account to make sure that you are clear of all fees charged to you.
Editor’s Note: Here’s some more material on investing in gold.
After looking over the web to find the most trusted brokers from our experience and others, we have narrowed our choices to three firms (though there are a lot of good ones out there) to buy gold stocks online (and/or ETFs if you were swayed by this article). First, TD Ameritrade, a subdivision of Toronto Dominion Bank is a firm that provides affordable solutions with no account minimum. Commissions will cost you $9.99 per trade, with no account minimums, and you will receive cash bonuses based on your deposit value. Another important point to mention is that TD Ameritrade contains 100+ commission-free ETFs which is fantastic!
Second, you can go with Charles Schwab, a broker which allows you to trade with a $1,000 minimum but a lower commission compared to TD setting you a more affordable $8.95 per trade. There are also promotions going on for 500 commission-free stock trades if you deposit a certain minimum in deposits. What’s better than the 100+ commission free ETFs that TD offers? How about 200+ commission-free ETFs at Charles Schwab!
Third, we will look at an option for the Canadian crowd with Questrade. This firm has a unique commission pricing at $0.01 cent per share with a minimum fee of $4.95 to a cap at $9.95 per trade. ETFs are commission free just like the other two brokers. However, the variety of ETFs is lower on Questrade in comparison to TD and Charles Schwab.
At the end of the day, like stated before, do your due diligence to make sure that the broker of your choice is the best one for you.
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