The Most Affordable Way to Buy Gold: Physical Gold or ETFs?

By Jean Folger | March 19, 2013 AAA
The Most Affordable Way to Buy Gold: Physical Gold or ETFs?

Gold – valued as a currency, commodity and investment for thousands of years – is popular among today’s investors because it can be used as a hedge against currency devaluation, inflation or deflation, and due to its ability to provide a "safe haven" during times of economic uncertainty. The gold market is highly liquid and there are a number of ways in which investors can gain exposure to this precious metal, including holding physical gold (i.e., gold coins and bars) and exchange traded funds (ETFs).

Physical Gold
Physical gold provides the most direct exposure to gold. Gold in bulk form is referred to as bullion, and it can be cast into bars or minted into coins. Gold bullion’s value is based on its mass and purity rather than by a monetary face value. Even if a gold coin is issued with a monetary face value, its market value is tied to the value of its fine gold content.

Investors can buy physical gold from government mints, private mints, precious metal dealers and jewelers. Because different sellers may offer the exact same item at different prices, it is important to do your research to find the best deal. When you purchase physical gold, you must pay the full price.

Physical gold ownership involves a number of costs, including storage and insurance costs, and the transaction fees and markups associated with buying and selling the commodity. There can also be processing fees and small lot fees for investors making small purchases. While collectively these costs may not significantly affect someone looking to invest a small portion of their portfolio in gold, the costs may become prohibitive for investors seeking to gain larger exposure.

Gold ETFs
Unlike physical gold, ETFs can be purchased on margin, meaning that investors only front a percentage of the investment’s value. ETFs allow investors to access gold while avoiding the costs and inconvenience of markups, storage costs and security risks of holding physical gold. An investor will lose a percentage of his or her investment’s value each year to the fund’s expense ratio. An expense ratio is the recurring annual fee charged by funds to cover its management expenses and administrative costs. The largest gold ETF – the SPDR Gold Shares ETF – for example, has an expense ratio of 0.40%. That means an investor would pay $80 per year in fees for a $20,000 investment.

Investors will also pay a commission for buying and selling an ETF. While most online commissions run under $10, the commissions can really add up if you are an active trader. In addition, brokers typically charge a higher commission that can be upwards of $25 per trade for broker-assisted trades, automated phone orders and special order types.

To address investors’ concerns regarding ETF commissions, some brokerages now offer commission-free online trading for a specified suite of ETFs. For example, you can trade the ETF Securities Physical Swiss Gold Shares ETF (NYSEArca:SGOL) for free at the Schwab ETF OneSource platform. As of writing, however, only two brokerages offer commission-free trading on any gold ETFs – SGOL on Schwab, and the 2X Gold Bull/S&P 500 Bear ETF (NYSEArca:FSG) on Interactive Brokers.

There are more than a dozen gold-specific exchange traded products available today, including inverse and leveraged ETFs. Keep in mind that you do not own any physical gold even if you invest in a physically-backed ETF: you cannot redeem or sell shares in exchange for gold.

Here are today’s five most affordable gold funds by expense ratio:

iShares Gold Trust (NYSEArca:IAU)
The iShares Gold Trust is designed to correspond generally to the day-to-day price movement of gold bullion and shares are backed by physical gold. The fund is backed by physical gold held in vaults in Toronto, New York and London. IAU, which was launched on Jan. 21, 2005, has an expense ratio of 0.25% and total net assets exceeding $11 billion.

E-TRACS CMCI Gold Total Return (NYSEArca:UBG)
E-TRACS CMCI Gold Total Return is designed to track the performance of the UBS Bloomberg CMCI Gold Total Return (the “Index”). Rather than investing in physical gold, this fund invests in a portfolio of gold futures contracts. Launched on April 1, 2008, UBG has an expense ratio of 0.30% and total net assets of $16.30 million.

ETF Securities Physical Swiss Gold Shares
ETFS Physical Swiss Gold Shares is designed to track the price of physical gold bullion, and shares are backed by physical gold held in trust in Switzerland. SGOL, which was launched on Sept. 9, 2009, has an expense ratio of 0.39% and total net assets of nearly $1.9 billion. Investors can trade SGOL with $0 online commissions at the Schwab ETF OneSource platform.

ETF Securities Physical Asian Gold Shares (NYSEArca:AGOL)
Physical Asian Gold Shares is designed to track the price of physical gold bullion. The gold is held in trust and stored in Singapore. AGOL, which was launched on Jan. 14, 2011, has an expense ratio of 0.39% and total net assets of about $78 million.

SPDR Gold Shares (NYSEArca:GLD)
The SPDR Gold Shares ETF is designed to the spot price of gold bullion and the fund holds 100% physical gold held in HSBC’s vault in London. GLD, which was launched on November 18, 2004, has an expense ratio of 0.40% and total net assets exceeding $65 billion.

The Bottom Line
The transaction costs associated with gold ETFs are often lower than the costs related to the purchase, storage and insurance of physical gold. It is important to research the various costs, fees and associated expenses of each type of investment to determine the investment that is both affordable and suitable for your portfolio.

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