Gold exchange-traded funds (ETFs) can either consist of gold mining companies or be backed by physical gold. ETFs backed by gold operate simply: When the price of gold goes up, investors make money. When the price goes down, investors lose money. Like any investment, there are pros and cons to investing in a gold ETF.
Here are two reasons why a gold ETF may be good for your portfolio and one reason you may want to avoid it.
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1. It can help protect your portfolio during rising inflation
Gold is dollar-denominated, so its underlying value is in dollar terms. Because of this, gold and inflation have a paired relationship. When inflation occurs -- like the 7.9% inflation rate between February 2021 and February 2022 -- investors want to find alternatives to their cash holdings because their purchasing power decreases.
Gold is a popular asset to consider during inflation, and it sets off a chain reaction. Inflation occurs, which increases the demand for gold, and in turn, this increased demand increases the price of gold and raises the value for current gold owners. That's why gold has historically been viewed as a hedge against inflation.
2. It eases the logistics of owning gold
Investing in physical gold can come with logistical obstacles. Gold bars, known as bullion, are popular choices for people looking to buy physical gold. In addition to finding a reputable seller (to ensure the gold is real), you have to think about the care needed and the cost of shipping the gold.
Before you receive the gold, you need to think through storage options. Although storing the gold in your home is an option, many people prefer to use a custodian, which is also an added cost. If you decide to store the gold at home, you'll likely want to insure it, also adding to the cost.
Gold ETFs remove these logistical barriers. With a simple purchase in an IRA or brokerage account, you can get the benefits of owning gold without worrying about the manufacturer, transportation, or storage. The minimum size bullion generally allowed for purchase is 1 gram, potentially presenting a problem for anybody looking to invest a small amount. With gold ETFs and brokerage companies offering fractional shares, you can be invested in gold with as little as $1.
Gold ETFs may face a higher maximum long-term capital gains rate
If you purchase an asset and sell it within a year, the profit you make from it will be taxed at your regular income tax rate, which is anywhere from 10% to 37%, depending on your income level. If you hold the investment for longer than a year, any profit you make will be taxed at your capital gains rate, which can fall into one of three ranges:
| 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.
However, there are a few exceptions, such as the tax applied to assets deemed as collectibles, like precious metals, art, coins, stamps, etc. Although gold ETFs work like any other ETF in that they're traded on the stock market like single company stocks, any ETF backed by gold is considered a precious metal and may face a higher 28% capital gains tax.
If your regular income tax rate is below 28%, you'll pay whatever your rate is. If you're in the 32%, 35%, or 37% tax bracket, you'll receive a break because the tax on collectibles won't exceed the 28%.
