A gold exchange traded fund (ETF) is a complicated investment. The most important rule of investing is: never invest in something you don’t completely understand. For almost every investor, that means stay away from ETFs.
A gold ETF is essentially basket of derivatives that aims to reflect a certain market index. What makes it different from other index funds is that it trades just like company shares do on the stock exchange. As we know from above, the net asset value of a mutual fund is calculated at the close of each trading day. The price of an ETF changes throughout the trading day. Though an ETF tries to mirror the index’s return, it is not guaranteed to do so.
Many gold ETFs own physical gold bullion to back the shares, and price the shares according to the price of gold. This allows investors an easy way to have part of their portfolio rise and fall with the price of gold, effectually allowing them to profit from gold without needing to physically store it.
Investors place their money in ETFs because they want to diversify their portfolios while having the trading flexibility inherent with stocks. Though this may sound attractive, ETFs carry a lot of risk, for several reasons. Namely, the investors do not necessarily own any gold, they are at risk for fraud, and they are vulnerable to collapse.
An investor needs to understand that an ETF does not represent an investment in gold. Gold ETFs monitor companies within the gold industry but they do not own any gold. Though the ETF may be backed by gold, the investor owns the equivalent of a derivative, not gold. A derivative is a security whose price is derived from or depends upon an asset.
The most troublesome aspect of ETFs is that they put the investor at risk for fraud. Because there’s so much paperwork involved with ETFs, you’re never entirely sure Gold coins are something that an investor can actually see and touch, so the individual knows what is owned. Investment in an ETF requires relying on the honesty of various accounting and financial professionals. The investor is exposed if any of those individuals are involved in illicit practices. For more on why gold ETFs are vulnerable to collapse, read my guide published earlier here.
Those investing in gold because they fear economic collapse should not turn to ETFs. Paper assets such as these do not provide easy access to the investment in a time of need and will lose all value if the economy collapses because they are not backed by holdings in an actual commodity. Instead, investors should seek tangible assets that they will still have after an economic wipeout. Think: gold coins.
Next Part: Gold Futures