An investor might have several reasons to own gold: as a hedge against inflation, to prepare for economic chaos, to hedge against devaluation of paper money and as a way to diversify an investment portfolio. Rather than personally storing the physical metal, investors can buy shares of mutual funds that hold gold bullion and coins.
Physical Gold Mutual Funds
A physical gold mutual fund issues shares backed by a stockpile of the yellow metal. You can open an account with the mutual fund company or with a brokerage that handles the fund’s shares. When you contribute money to the fund, you own a slice of its holdings. The share price is the net asset value, which will fluctuate with the price of gold. Physical gold mutual funds may generate some capital gains or losses because of customer "redemption churn." Existing customers may sell their shares, forcing the fund to raise cash by selling some of its gold. Those sales may create capital gains, which the fund will pass on to you as taxable income. However, physical gold mutual funds do not create significant income because gold pays no dividends or interest.
A physical gold mutual fund hits you with fees to cover storage costs and administrative fees. The fund may tack on a sales charge and/or redemption fee. You pay for the fund manager as well -- usually as a percentage of your assets under management. For example, you may scoop up shares in a physical gold mutual fund that carries a 5.25 percent sales load, a 1 percent management fee and a 0.75 percent fee for expenses. If you invest $1,000 and the price of gold remains unchanged for one year, your account will swan dive to $930 by the time the year passes just to cover costs. As of 2013, because the Internal Revenue Service considers gold a collectible, it taxes you at your marginal tax bracket on gains from selling shares you held for a year or less, and up to 28 percent on longer-term holdings.
Closed-End Mutual Funds
A physical gold closed-end fund is a mutual fund with shares that trade on exchanges. You buy these shares using a brokerage account, just as if you were purchasing corporate stock. The CEF does not create or destroy shares according to investor activity. Rather, it issues a fixed number of shares through an initial public offering, backed by an underlying supply of gold metal. Unlike open-end funds, CEFs do not redeem shares, so they avoid redemption churn that might produce capital gains.. Another unique feature of CEFs is that they can sell covered call options on their gold holdings, creating a source of steady income. CEFs often sell at a discount to their net asset values, which increases the yield on the options-based income. According to Barron’s, Americans who buy shares of Canadian physical gold CEFs organized as “passive foreign investment companies” pay capital gains taxes rather than the collectibles tax.
Buying and storing your own gold might be an expensive hassle. You will need to ensure your holdings and might need to rent storage space. You might want to compare long-term costs of holding your own metal versus owning shares of a physical metal mutual fund. If you do decide to stockpile your own metal, always take physical custody of it: Gold dealers that offer to store your gold for you might be frauds. You also might consider exchange-traded funds holding physical gold, which you can purchase on the stock exchange through your brokerage account. Like CEFs, ETFs avoid redemption churn, but the shares are usually more liquid -- easier to sell -- than those of CEFs. Yet another alternative for those who want to benefit from rising gold prices without owning the physical metal: mutual funds that invest in gold futures and/or shares of gold-mining stocks.
- Silver Monthly: Gold Mutual Funds: Alternatives to Holding Gold
- Wall Street Journal: How to Invest in a Closed-End Fund
- Seeking Alpha: The Gabelli Equity CEFs: Leveraged Funds for a Bull Market
- Barron's: Getting Socked by Gold Fund Taxes? Consider These CEFs
- Seeking Alpha: ETFs vs. CEFs
- International Business Times: Glenn Beck-Linked Gold Dealer Facing Fraud Charges
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.