Precious metals like gold and silver stand out among commodities for being a little different. Unlike other commodities like oil or wheat, precious metals serve in a number of capacities. They have some value as an industrial metal, but they are primarily used as safe-haven investments.
Many financial professionals even recommend holding a small percentage, around 5% or so, of your portfolio in precious metals – typically gold – for use as a safe-haven investment. Keeping a small amount in these types of assets can hedge against inflation and help protect your wealth against a fluctuating U.S. dollar value.
By adding a precious metals fund to your portfolio, you can add more diversification to the mix and reduce overall risk.
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What You Need to Know About Investing in a Precious Metals Fund
Precious metals mutual funds primarily operate in two different ways – futures/physical assets and mining stocks. While it might seem like the difference is simply a matter of asset choice, the way profits are actually made by the fund makes a difference for your risk tolerance and portfolio needs.
To begin with, mutual funds that invest in physical assets and futures are an ideal way for investors to gain access to precious metals. Trading futures is an investment activity reserved only for sophisticated investors with a large pool of capital to work with. Many futures contracts come with minimums of $50,000 or more in order to even initiate a position. Risks are amplified by the way of high leverage as well – sometimes in excess of 100 to 1 meaning that a small drop in prices could result in double-digit losses. And the common mark-to-the-market accounting methodology that is frequently used means that positions are closed out and tallied at the end of each business day so even if you correctly predict where gold or silver prices end up at, a single day in correction could mean that your entire investment is lost.
Instead of having to manage a futures portfolio, a mutual fund offers professional management that keeps your risk low. This type of fund is one of the best ways to invest in gold or silver without actually purchasing a physical asset. If you’re interested in a future fund, the Gold Bullion Strategy Investor Fund (QGLDX) invests in both bullion and futures contracts but does come with a fairly high expense ratio of 1.41%.
The other type of precious metals mutual fund invests are mining stocks rather than futures contracts or physical assets. Some funds may even have a mix of everything. It’s important to note the distinction between investing in a precious metals mutual fund and investing in a precious metals stock. These funds profit from the underlying value of the stock rather than the physical value of gold or silver. Due diligence should always be done to ensure that the selected mutual fund invests in the type of assets your portfolio requires.
As the most common type of precious metals mutual fund, investors will be able to diversify their portfolio to include a wealth of mining and exploration companies. Instead of selecting a single mining company for your stock portfolio, a mutual fund gives you a broad exposure to gold, silver, platinum and other types of precious metals.
One other important takeaway for investors is the expense ratio that comes with precious metals mutual funds. While having active management is one of the biggest pluses for investors, it usually means a higher expense ratio that could hurt long-term returns. But many precious metals funds have some of the lowest expense ratios outside of index funds. While some come with ratios over 1%, the Vanguard Precious Metals and Mining Fund (VGPMX) comes with a relatively cheap 0.36% expense ratio.
A Note About Precious Metals as a Safe-Haven Investment
One of the biggest reasons investors choose to buy gold and silver in their portfolio is to hedge against inflation. Because these metals hold their value independently from the U.S. dollar, they can effectively protect money when the value of the dollar declines due to inflation.
But inflation alone isn’t enough to actually make precious metals valuable as a hedge investment. Inflation needs to be higher than interest rates in order to actually preserve wealth. Otherwise, because gold and silver do not appreciate like stocks, investors are better off investing in assets that outpace inflation.
The Bottom Line
Precious metals funds give investors broad access to safe-haven assets and can help mitigate risks from market downturns and inflation. While buying physical gold is a viable solution for investors seeking wealth preservation, precious metals mutual funds give investors a chance to profit from increased metals prices while still serving a purpose of preserving wealth and hedging against inflation.
Gold and silver investments also offer an additional layer of diversification to your portfolio. While most assets like stocks or commodities like wheat will suffer from lower demand as prices rise, precious metals will see higher demand instead. And its performance is often inversely related with other asset classes – as stocks go down, gold and silver values will go up.
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