Gold in a portfolio

In short

A friend of mine once kept a coin in his sock drawer for thirty years, and he never once asked what it had earned him. If you own gold, or you are thinking about it, you deserve a straight look at how it works. Gold is a metal that pays no interest and no dividend. Its price moves up and down, sometimes hard, and the only way you gain is if someone later pays more for it than you did. You can hold it as coins, as bars, or through a fund that tracks its price, and each way has its own costs. Decide how much of your money you would put in, and write that number down before you buy anything. Then check the fees, because small fees add up over long stretches.

The whole of it

What it is

I once watched an old farmer weigh a gold ring in his palm as if it were a living thing. You have probably felt that pull too. Gold has been treated as valuable for thousands of years. People shaped it into jewelry, stamped it into coins, and stacked it in vaults.

In a portfolio, gold sits in its own corner. A share of stock is a piece of a business, and a business can earn profits and share them with you. A bond is a loan, and the borrower pays you interest. Gold is neither of those. It is a thing you own. It makes no profit and sends no checks. Its value comes from what other people will pay for it on a given day.

That is not a flaw, and it is not a promise either. It is simply the nature of the thing. Some people hold a little gold because it has not always moved in step with stocks and bonds. Others hold none, because they prefer assets that produce income. Both choices are reasonable. The point is to know which kind of owner you are.

How it works

A woman I know bought a gold fund thinking it worked like a savings account. It does not, and she was a good sport about learning that. So let us walk through the ways you can own gold, and how each one touches your wallet.

You can buy physical gold, such as coins or bars. You pay the market price plus a markup, called a premium, to the dealer. When you sell, the dealer often pays you a little less than the market price. That gap is a real cost. You also have to store it safely, and safe storage may cost money or take effort.

You can buy shares of an exchange traded fund, often shortened to ETF. An ETF is a basket you can buy and sell through a brokerage account, just like a stock. Some gold funds hold real bars in a vault and track the price of gold. Each fund charges a yearly fee, called an expense ratio, taken out of the fund as a percent of your holdings. The fund's own paperwork, called a prospectus, lists that fee.

You can also buy shares of gold mining companies. That is a different animal. A mining company is a business, so its shares rise and fall with its costs, its management, and its luck, as well as with gold prices. Do not confuse the miner with the metal.

Taxes matter here too, and they surprise people. The IRS has its own rules for how it taxes gains from certain physical metals and from funds that hold them. The rate may differ from what you pay on a regular stock. The IRS pages on this are worth reading before you sell, since the treatment can change how much you keep.

The numbers, and where to find yours

Every number in gold investing lives somewhere you can look up. Each one has a home, and you can go and read it for yourself.

Start with the price. The spot price is the going rate for gold right now, and any large financial news site or dealer shows it. Next, find your fee. If you own a fund, the expense ratio is in the fund's prospectus and on its page at your brokerage. If you own physical gold, the premium is on your dealer's receipt or price sheet.

Then find your tax rate. The IRS explains how it treats gains on collectibles and on gold funds in its Publication 550, Investment Income and Expenses. The rate on long term gains from collectibles is set by law, and it is the current figure, which the official source publishes each year. Whether your holding counts as a collectible depends on how you own it, so check that page for your case.

Finally, know your own share. Look at your total investments and ask what portion sits in gold. That percent is yours to choose. No law sets it for you.

A worked example

I like a story with real numbers, so let me tell you about a woman named Ruth Hollis. Ruth is 45, and she has 200,000 dollars invested in all. She reads about gold and decides she would like a small piece of it, about 5 percent of her money.

Here is her math. Five percent of 200,000 dollars is 0.05 times 200,000, which equals 10,000 dollars. So Ruth plans to put 10,000 dollars in gold.

She picks a gold fund with a yearly fee of 0.40 percent. On her 10,000 dollars, the fee is 0.004 times 10,000, which equals 40 dollars a year. That is what the fund takes, whether gold rises or falls.

Now suppose she held it for ten years and the price never moved. She would have paid about 40 dollars a year for ten years. That is 40 times 10, or 400 dollars in fees, and her gold would be worth about what she paid, minus that 400. She would have earned no interest and no dividend along the way.

Now suppose gold rose 20 percent over those years. Her 10,000 dollars would grow by 0.20 times 10,000, which is 2,000 dollars, bringing it to 12,000 dollars. Take away the 400 in fees, and she keeps about 11,600 dollars before any tax. Then a tax applies to her 2,000 dollar gain, at whatever rate the IRS assigns to her kind of holding.

Ruth might just as easily see the price fall. If gold dropped 20 percent, her 10,000 dollars would shrink to 8,000, and she would still have paid the fees. She understood both stories before she bought, and that is the whole reason she felt calm.

Where it goes wrong

I have watched good people stumble here, and they were no fools. They simply did not see a few things coming.

The first trap is thinking gold is safe. Its price can swing a great deal, and it can stay low for years. Gold has no promise attached to it. Nobody guarantees that it rises.

The second trap is forgetting the costs. A premium on a coin, a dealer's buy back gap, storage, and a yearly fund fee each take a bite. A bite that looks small can grow large over a long stretch. Add them up before you commit.

The third trap is buying out of fear or hurry. A loud headline can make anyone want to rush. If you feel that push, wait a day. Your money will keep.

The fourth trap is putting in too much. A big share in one thing that pays nothing can leave a portfolio lopsided. That is a plain matter of arithmetic.

The last trap is scams. Some sellers push overpriced coins or make bold claims. The Federal Trade Commission and the Commodity Futures Trading Commission both publish warnings about precious metals fraud. A quick read of their pages is time well spent. Be wary of anyone who pressures you.

Questions to answer before you leave this page

What job do I want gold to do in my portfolio, and would something else do that job for less money? What share of my total savings am I really comfortable putting into something that pays no interest or dividend? Which way of owning it fits me, whether coins, a fund, or mining shares, and what does each one cost me each year? Have I found the fee in the prospectus or the premium on the price sheet, and have I done the math on ten years of it? Do I know how the IRS will tax a gain on the kind of gold I hold, and have I read its page? Could I sit calmly through a long stretch where the price falls or goes nowhere? And have I decided my number in writing, before anyone tried to sell me anything?