Short of stockpiling bullion in your basement, an ETF is the most cost-effective vehicle for owning gold. But you cannot just pick any fund out of the available list of seven bullion-based funds and expect it to perfectly track the price of gold and offer the lowest expense ratio.
First of all, no exchange-traded fund will track the price of gold perfectly because returns are offset by costs -- management fees and brokerage costs to buy them. Gold ETFs vary in fees, with the average annual expense ratio for the category at 0.54 per cent, although you can find a fund charging as low as 0.25 per cent. You need to weigh carefully what's important to you: The size and liquidity of the fund or annual expenses. Which fund you buy depends upon how you plan to own it.
As I have mentioned in the past, gold is not a perfect investment. Many pundits legitimately claim gold is a shadow currency because major banks, traders and governments buy it to hedge against currency devaluations. When the dollar gains against other currencies or consumer confidence comes back in the United States or Europe, though, gold will not shine. Rising US interest rates in the US will also hurt the metal's price.
Since gold is so volatile, do not invest more than 10 per cent of your portfolio in it. You would need look no farther than last Friday for an example of the risk; gold fell nearly 2 per cent -- its biggest one-day drop in three months.
Two funds are leaders in terms of size and visibility: the SPDR Gold Trust and iShares Gold Trust. These two ETFs come up most often in lists of recommended funds.
WHY THE SPDR?
Gold ETFs are fairly convenient vehicles. They hold the metal for investors in huge vaults. If investors buy shares, they buy more gold. Fueled by anxiety over US and European debts, about $8 billion has flowed into gold ETFs in the third quarter -- the highest quarterly inflow in two years -- according to ETFTrends.com, a site that follows exchange-traded funds.
The big gorilla of gold ETFs is the SPDR Gold Trust (GLD). With assets of more than $74 billion, it's one of the largest ETFs of any kind. The fund's manager says it keeps its 1.3 metric tons in the vault of HSBC bank in London, or in "vaults of sub-custodians."
While holding the SPDR is much less expensive than purchasing the metal and storing it yourself, the managers charge you 0.4 per cent annually for this service, which is just under the average for this kind of fund (0.54 per cent). The fund is up 13 per cent year to date and has risen 20 per cent for the past three years.
For frequent traders, the SPDR's liquidity makes it a good choice since its volume in terms of shares (more than 3 million daily) and options traded is the highest of any gold fund.
THE iSHARES OPTION
You could save on annual expenses and reap a slightly better longer-term return by owning the iShares Gold Trust (IAU), which also holds about $10 billion in bullion. The fund's expense ratio -- what the manager charges you for managing the fund each year -- is just 0.25 per cent. It has returned about 23 per cent over the past three years through October 19 and 6.6 per cent year to date. I hold this fund in my 401(k).