How to Invest in Gold the Right Way

Photo: Mykl Roventine

The expression “as good as gold” suggests that gold is something of a sure thing when it comes to investments. But, while gold and other commodities remain a solid investment choice, when it comes to investing there’s no such thing as a sure thing. The trick to investing in gold is knowing the difference between gold and other asset classes; stocks, bonds, real-estate, even cold hard cash.

Putting a Value on Gold

Let’s start with its value or, as with so many things, its perceived value. Valuing gold is a tricky thing. Without earnings or cash flow (which is the most commonly used metric in valuing a company and its stock) it can be tough to identify the appropriate valuation of gold. How many dollars should an ounce of gold be worth? The spot price is simply dependent on the market forces of buyers and sellers; therefore, for the price to increase, you need more buyers than sellers. So rather than speculating, consider the following approach.

Gold as Insurance

Don’t trade gold. Moving in and out of a gold position, like many do with stocks is not a smart strategy. Gold, historically, is very volatile and has erratic movements in its spot price. Attempting to guess short-term price movements is near impossible.

The right way to view gold is as insurance. The beautiful thing about gold is that it is very tough to manipulate its price, especially over time. Stocks, bonds, and even currencies can be manipulated by political powers through monetary policy and government action. Gold will keep its value through a wide range of economic scenarios which is one reason it is so appealing during an economic downturn such as the one we are currently suffering through. As such, it can be held in order to insure against risks to your other assets. So, what are the risks?

The number one risk that you should be prepared for is the loss of purchasing power of your currency. Typically this happens whenever the government attempts to manipulate the economy in some way. The latest attempt to “fix” the struggling economy has only delayed the inevitable by increasing the national debt. The influx of cash from the economic stimulus package needs to be paid for somehow. And the usual result of this kind of spending spree is a debasement of the currency and/or inflation. When inflation occurs, your dollars are worth less. Put in layman’s terms, it is akin to attempting to dig yourself out of a hole. More debt creation will not result in getting us out of debt. So how can you protect yourself against this risk? You need insurance.

Now, just like you should not put all your eggs in one basket for a specific stock, you should not be betting the farm on an increase in the price of gold either. Liquidating all of your assets and buying gold would be a little extreme. Instead, insure your assets and your purchasing power by allocating a percentage of your assets in precious metals such as gold. Most experts recommend allocating somewhere in the range of 10%-30% of your assets. If you’re new to the gold game, start with 10%.

How to Buy and Own Gold

Ain’t nothing like the real thing baby. Part of your gold allocation should be in real, physical gold that is in your possession. You can purchase gold coins or bullion from precious metal dealers. Obviously, you will need to give good thought to where and how you will store your gold and protect it from theft or loss. Sorry, Fort Knox is not an option.

You can also consider buying ETFs that attempt to track the spot price of gold. You can purchase these ETFs (such as GLD) like any other stock through your brokerage account.

Lastly, you can consider creating an account with a company like GoldMoney. GoldMoney allows you to deposit cash and keep your account balance in gold. When you wish to withdrawal your funds, you will then transfer your money back into cash based on the spot price of gold at that time.

If you’re concerned that the price of gold has already risen considerably over the previous years (which it has), consider dollar cost averaging into the appropriate size position that you wish to hold. Buy a fixed number of gold coins each month or every couple months. This will help prevent buying all of your gold at one time which might be at a relatively high price.

Speculating on the price of gold can be as risky as any other form of investment. Instead, use it as a hedge against inflation and a way to gain additional diversification. But don’t take my word for it. As with any investment be sure to do your own research.

For more of Kevin’s writing, visit personal finance blog 20smoney.com.