Exchange-traded funds (ETFs) are popular options for those looking to invest passively. With inflation reaching levels not seen in decades, many are now wondering if investing in gold is a good hedge.
Gold ETFs allow you to invest in gold without dealing with the logistics of transporting and storing it. While gold may have its place in portfolios, here's why gold ETFs may not be the best option for you to choose.
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They potentially face higher capital gains taxes
Long-term capital gains -- which are investments held for longer than one year -- are taxed more favorably than regular income taxes. While income taxes fall into one of seven brackets ranging from 10% to 37%, capital gains are generally tax-free or subjected to a 15% or 20% tax, depending on your income level.
| Income Range | Long-Term Capital Gains Tax Rate |
|---|---|
| $0 to $40,400 | 0% |
| $40,401 to $445,850 | 15% |
| $445,851 or more | 20% |
Data source: IRS. Chart by author.
There are a few exceptions, however. Three asset types face a higher maximum 28% capital gains tax: small business stock, property under Section 1250, and assets categorized as collectibles (such as coins, art, and precious metals). While many ETFs are taxed like regular stocks, gold- and silver-backed ETFs fall into the precious metals category and face the higher maximum capital gains tax rate.
So, if you make $400,000 and sold an all-stock ETF for a $10,000 profit, you'd owe $1,500 in taxes; if it were a gold ETF you sold for the same profit, you'd likely owe $2,800 instead. A difference of 13 percentage points in tax rates adds up and can make a tangible difference in your total retirement savings in the long run.
They're relatively expensive to own
While it's now industry-standard to offer free trades, ETFs come with expense ratios, which are charged as a percentage of your total investment. If you invest $10,000 in an ETF with a 0.25% expense ratio, it would cost you $25 annually to hold the investment. Gold ETFs often have higher expense ratios when compared to other popular index funds such as the S&P 500.
iShares Comex Gold Trust (IAU 0.57%) and SPDR Gold Trust (GLD 0.60%) are two popular gold ETFs with expense ratios of 0.25% and 0.40%, respectively. While these expense ratios are less than the average gold ETF -- which is 0.63%, according to Morningstar -- they're still on the higher end. For example, the Vanguard S&P 500 ETF (VOO -0.41%) has an expense ratio of 0.03%.
The difference in these percentages may seem small, but they can represent a lot of money over time. If you were to accumulate $100,000 in each of the three funds mentioned above, here's how much you would pay in fees with each.
| ETF | Expense Ratio | Annual Fee Per $100,000 Invested |
|---|---|---|
| IAU | 0.25% | $250 |
| GLD | 0.40% | $400 |
| VOO | 0.03% | $30 |
Data source: Author calculations.
If you build up a substantial enough investment over time, you could be paying thousands more in fees.
There are other means of diversification
One of the golden rules in investing is to make sure you diversify your assets -- and gold, without a doubt, helps with that. However, given the potential tax ramifications and higher expense ratios you're likely to experience, it may be more beneficial to utilize index funds like the S&P 500, which also give you instant diversification with one purchase. Focusing on the cost to own an investment is a good strategy to ensure you're not cutting too much into your returns and paying more than you have to.
