8 Risks of Investing in Gold and How to Minimize Them

Gold has long been a popular investment for diversification. Its low correlation with stocks and bonds can help offset losses when other assets decline.

But it’s important to consider all the costs associated with investing in gold. Physical bullion, for example, can carry hidden storage and insurance costs, as well as capital gains tax when you sell.

1. Market Volatility

Market volatility is a normal part of the investing process and can affect investments at any time. It can result from unexpected economic news, changes in monetary policy by the Federal Reserve, political/geopolitical events and even inflationary pressures.

Investors may experience fear or anxiety during periods of high market volatility, but the best strategy is to remain calm and stick with your plan. Veering off course in the face of market volatility could ultimately jeopardize your long-term investment goals.

While a volatile market can be frightening, it also presents a unique opportunity for profit. It is important to think strategically in these types of markets and consider rebalancing your portfolio. For example, if you have a higher percentage of emerging market stocks in your portfolio than usual, after a significant market drop, it could be beneficial to rebalance and move some money into other asset classes like bonds or domestic stock.

Volatility can also occur within a specific industry or sector. For instance, a natural disaster in an oil-producing region can increase demand and drive up the price of oil, which can directly impact the share prices of companies that distribute oil products.

2. Leverage

Gold is often viewed as a hedge against inflation or as an investment in the event of currency devaluation. It is also considered a safe haven in times of global economic uncertainty.

However, it’s important to understand that gold is not risk-free and investors should consider their own risk tolerance before including it in a portfolio. Physical investments like bars and coins can be subject to manufacturing, distribution, storage and insurance costs, which can lower the potential returns of this asset class.

In addition, households tend to significantly underestimate the volatility of gold and overestimate its return expectations. As a result, many times over shorter time periods, equities have outperformed gold by a wide margin. While gold can reduce the risk of an equity and bond portfolio in uncertain times, it’s important to weigh all of your options carefully before adding it to your investments. There are various ways to get exposure to gold, including physically holding bullion and coins and indirect, paper-based exposure through gold mining stocks, ETFs and mutual funds.

3. Counterparty Risk

Investing in physical gold bars and coins or exchange-traded funds (ETFs) that track the price of the yellow metal can provide a safe-haven asset that’s free from counterparty risk. This type of risk refers to investments that depend on the fulfilment of transactions by a third party, such as companies that mine and refine gold or issue paper assets like shares.

While gold’s performance varies over time, it typically performs well during periods of global economic uncertainty. Its reputation as a crisis commodity can draw investors during times of political unrest or rising inflation. This is why gold is often seen as a low-risk diversifier for investment portfolios.

In addition, gold prices tend to have a low-to-negative correlation with other asset classes, such as stocks or bonds. This helps reduce the impact of sharp losses in other parts of your portfolio. However, this “investment insurance” comes at a cost: Over the long term, adding gold to a portfolio has typically reduced overall returns. This is a similar trade-off to that of buying home insurance, which can lower your overall income over the long run.

4. Taxes

The most obvious risk associated with investing in gold is that the value of your investment could decline while you hold it. This is known as market risk, and it can be mitigated by diversifying your portfolio with other assets.

Buying physical gold can also come with additional costs, such as storage fees and capital gains taxes. In addition, unlike many other investment assets, gold doesn’t produce a yield while you own it. Gold mining company shares may be a better option if you want to gain exposure to gold without owning the metal, but share prices are influenced by more than just gold price trends—production costs, reserves and exploration all factor into share performance.

While investing in gold is considered low risk, it’s important to consider all the risks involved and determine if it’s the right fit for your financial goals. Investing in precious metals is a great way to protect your wealth and diversify your portfolio, but it’s always best to speak with a financial professional before making any decisions.

5. Liquidity

Gold is a highly liquid investment, meaning that it can be bought and sold easily without affecting its price. The more liquid an asset is, the closer the buying and selling prices converge, which lowers transaction costs for investors. A Review of Augusta provides tips for people who are planning to invest in gold.

Investing in physical gold bars or coins can be expensive, especially when you factor in storage costs. But gold-backed paper assets, such as gold stocks and funds or eTFs can be an easier way to add this precious metal to your portfolio.

Investors should be aware that even gold-backed paper investments are not without risk. They are subject to market volatility and other factors, including liquidity risk. Liquidity in options markets refers to how easy it is for traders to buy and sell an option. It is measured by the bid-ask spread, which is the difference between the highest price a buyer is willing to pay for an option and the lowest price a seller is willing to accept for it. The wider the bid-ask spread, the less liquidity in the market.

6. Short-Term Investments

Investing for long-term financial goals can help you weather market volatility and reap higher profits. However, if you have savings goals less than a few years away, you might consider short-term investment options like high-yield savings accounts and government bonds.

These investments prioritize safety and liquidity. They also offer a higher rate of return than standard savings accounts, without the risk of losing your principal investment. They’re a great option for investors who need to access their money sooner rather than later.

When choosing short-term investments, look for products that offer lower fees to purchase and liquidate them. You should also avoid any that come with penalties for withdrawing your funds early, as this can significantly reduce the amount of money you earn. Additionally, avoid investing in securities that aren’t easily convertible into cash. These can include marketable securities, mutual funds and exchange-traded funds. Many individual investors use these types of investments to save for major purchases, home improvements or emergency savings. However, it’s essential to select the right investments for your unique financial goals.

7. Derivatives

Gold can be an important addition to your investment portfolio because it provides a hedge against inflation and offers a safe haven during economic uncertainty. However, it’s essential to understand the risks associated with buying and selling gold before investing.

Physical gold investments come with storage and insurance costs that can reduce your overall returns. Additionally, physical gold does not generate passive income through dividends or interest, so you’ll only receive a return on your investment when you sell it.

Paper gold investments, like gold mining company stocks and ETFs, are also susceptible to counterparty risk. This means that if the company that issues these securities fails or experiences financial turmoil, your investment could be wiped out. This risk is mitigated somewhat by using only established, reputable companies that offer the products you’re interested in. In addition, you can diversify your gold exposure by buying paper assets that are backed by different currencies, including the dollar. This helps to minimize your exposure to currency risk and global financial disruptions.

8. Collectibles

One of the fundamental tenets of financial planning is to diversify your investment portfolio. Investing in gold is one way to do so. Since it’s a tangible asset that doesn’t correlate directly with stock and bond markets, gold can serve as an effective hedge against market volatility and uncertainty.

Moreover, when traditional investments like stocks and bonds decline in value, gold often rises in price. As a result, it’s considered a “safe haven” asset during times of economic or political turmoil.

However, there are several risks associated with investing in physical gold. For one, storage costs are high, and it can be difficult to secure your assets against theft or damage. Additionally, investors who own physical gold must adhere to IRS requirements, such as using a vaulting service and paying fees on a regular basis. Fortunately, there are other ways to gain exposure to gold without taking on the risk of owning physical gold, such as through exchange-traded funds and investment trusts that track the spot price of the precious metal.