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Gold ETFs: All You Need to Know
By: The Motley Fool | November 10, 2018

Find out all the ways you can add gold exposure to your portfolio.

Most investors focus the bulk of their portfolios on three different asset classes: stocks, bonds, and cash. Yet even though you can be successful by concentrating in those areas, some investors prefer to add greater diversification by adding other types of investments. For millennia, gold has served as a store of value, with uses ranging from coinage and jewelry to dentistry and industrial electronics. With a reputation for resilience in the face of adverse macroeconomic trends like rising inflation and political uncertainty, gold has had periods in which it dramatically outperformed other types of investment assets.

There are many different ways to invest in gold, but one of the most popular involves buying shares of exchange-traded funds. ETFs give investors a chance to own small amounts of many different investments within a single fund, letting them get diversified exposure to gold without having to invest huge sums of money. Gold ETFs have attracted their fair share of the trillions of dollars that have gone into ETFs across the market, and their low costs and flexible approaches to investing in the sector make ETFs a useful way to add gold to a portfolio.

Below, we'll give you a list of several of the largest gold ETFs in the market, with detailed descriptions of the approaches they take and their advantages and disadvantages. First, though, let's take a bigger-picture view of how exchange-traded funds became so popular in the first place and how gold investors have used them to take very different approaches toward making money from the yellow metal.

How ETFs became a multitrillion-dollar business
To understand how exchange-traded funds got so popular, it's important to understand exactly what they are. ETFs are regulated investment companies that sell shares to investors and then pool together the cash they collect into common pools. Each ETF then takes the pool of money and invests it according to that ETF's particular investment objective. ETFs typically take a passive investment approach, which means that rather than actively making decisions about which investments are more likely to succeed than others, they simply track predetermined indexes that already set out which investments to make and how much money to invest in each. These index ETFs have the goal of matching the returns of the benchmarks they follow, although the costs of ETF operations usually introduce a slight lag below the index's theoretical return.

ETFs have gotten popular for many reasons. The most important is that ETFs let investors get diversification even if they don't have a lot of money. For less than $100 in most cases, investors can buy a single share of an ETF and get exposure to hundreds or even thousands of investments. That keeps investors from having to pick and choose just a small subset of the available investments in a particular area, and that in turn reduces the risk that you'll pick a losing stock and end up suffering a catastrophic loss of capital. ETFs protect their investors from big losses in a single stock, as long as its other holdings avoid the same risks.

ETFs are also popular because there are so many of them, with many different investment objectives. You can find funds for any asset class, including not only stocks and bonds but also commodities, foreign currencies, and many other less commonly followed investments. ETFs also vary in scope, with some drilling down on very small niches of an overall market or industry, while others look to offer the broadest possible swath of investments that meet its investment criteria. It's easy to find an ETF that matches your goals and wishes, because there are thousands of different funds to choose from.

Another big feature of ETFs is that their fees are generally reasonable. All a typical index ETF investment manager has to do is to match the performance of an index, which makes it unnecessary for the fund to do costly research or take other effort to try to enhance return. That makes these ETFs much less costly than traditional mutual funds that employ a more active management approach. Granted, because ETFs trade on stock exchanges, most brokers charge a stock commission to buy and sell shares. But increasingly, the trend has favored no-cost ETF trading, and more brokers are finding ways to encourage ETF investing for their clients.

ETFs have some tax advantages that also make them preferable to traditional mutual funds. The most important is that unlike mutual funds, ETFs almost never have to declare taxable distributions of capital gains that can add to your tax bill. That lets you decide when you want to realize any gains in the value of your ETF shares by selling them.

Lastly, investors can trade ETF shares a lot more freely than they can mutual funds. Whenever the stock market is open for trading, you can buy or sell ETF shares, but with a mutual fund, you can only buy or sell once at the close of the trading day. That gives ETF investors more latitude to respond to changing conditions quickly, rather than forcing you to wait until the end of the day -- when major moves might already have happened.

Why is gold an attractive investment?
Gold's appeal as an investment is rooted in history. Since the days of ancient civilizations, gold has been used in jewelry and coins, in part because of its beauty and in part because of its rarity. As a medium of trade, gold has the favorable monetary attributes of scarcity and compactness, as even small amounts of the yellow metal have enough value to purchase substantial amounts of many other goods. It's hard to counterfeit gold convincingly, as special characteristics like its relative softness and shine aren't shared by many other metals and other materials.

Over time, the supply and demand dynamics of gold have changed dramatically. On the supply side, advances in mining technology have made it easier and cheaper to extract gold from the earth, and that's increased the amount of available gold in the market. However, rising populations have also increased demand for gold for personal uses such as jewelry. Moreover, industrial uses for gold, including fillings for teeth and as a conductive material in high-end electronics, have also emerged and expanded over time. Even though gold coins no longer circulate in everyday transactions, investment demand for gold bullion -- which includes not only coins but also bars of pure gold specifically designed for investment purposes -- also plays a key role in sustaining demand for the yellow metal and keeping prices high. With commodity markets handling purchases and sales involving large quantities of gold, gold prices change on an almost continuous basis as the amount that buyers are willing to pay and sellers are willing to accept fluctuate.

What advantages do gold ETFs have over other gold investments?
Gold ETFs are just one way that investors can put money into the gold market. Alternatives include buying physical gold bullion directly, investing in gold futures contracts that trade on specialized exchanges and give buyers the right to have a certain amount of gold delivered to them for an agreed-upon price at a specific date in the future, or buying shares of companies in the gold business.

Each of these alternatives has pros and cons. Buying gold bullion through a dealer has the advantage of giving you actual physical gold that will track prevailing prices exactly, but the costs involved in buying, selling, and storing physical gold make it less than ideal, especially for those who want to buy and sell on a more frequent basis. Futures contracts offer the advantages and disadvantages of a leveraged investment, letting you control large amounts of gold with relatively little capital. But it's hard to get modestly sized positions in the futures markets, because most futures exchanges set contract sizes for 50 to 100 ounces of gold -- worth about $60,000 to $120,000 at current prices. Individual stocks in the gold industry let you tailor your exposure very precisely, with huge potential rewards if you pick a winning company but equally large risks if you choose poorly.

Gold ETFs have the advantage of letting investors put small amounts of capital to work effectively, and the range of ETFs in the gold space offer several attractive options for those seeking to invest in the yellow metal. Convenient trading and relatively low costs compared to dealers in physical gold also weigh in gold ETFs' favor.

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