Although there are many ways that you can invest in gold, they are broadly divided into two methods: buying physical gold and buying paper gold. Physical gold is what most people envision when they think of gold: coins, bars and jewelry. Paper gold, on the other hand, is intangible and comes in the form of financial assets, such as mutual funds or exchange-traded funds. Either way, you can participate in the ups and downs of the gold market. But you should be aware of the benefits and drawbacks of each type of gold before you make your decision.
Physical Gold: Pros and Cons
When comparing physical gold vs. paper gold, it helps to know the pros and cons of each. Here’s a look at the advantages of physical gold.
Pros of Physical Gold
If you’re looking for the most direct way to buy and own gold, physical gold is the way to go. Physical gold, at least for investment purposes, usually takes the form of coins, bars or ingots, as it is generally at least 99.9% pure and easy to value. Here are some of the other major pros of holding gold in its physical form:
- Tangibility: One of the best features of physical gold is that you can actually see it, touch it and hold it. In times of economic upheaval or uncertainty, investors tend to value assets that physically exist.
- Beauty: There’s something to be said for owning an investment that is beautiful to look at. In fact, the aesthetic appeal of gold is one of the reasons that it has been valued throughout history.
- Usefulness: In addition to being used throughout history as currency and as a store of value, you can always transform your physical gold into something else that provides value, such as jewelry or even industrial purposes.
Cons of Physical Gold
Physical gold isn’t without its drawbacks. Some of the most commonly cited are as follows:
- Markups: As physical gold is usually at least 99.9% pure, it’s easy to determine what its “true” value is. Unfortunately, when you’re buying physical gold, you will always pay over the current market value of gold, as dealers have to mark up the price to make a profit.
- Storage: If you own physical gold, you have to store it somewhere. Gold is heavy and relatively cumbersome, and it can be nerve-wracking to keep it at your house. If you prefer to have a custodian store it for you, they will charge you fees to do so. You will also have to pay for insurance.
- Illiquidity: While you can always find a buyer for your gold, you may not get a very good price if you are eager to sell. As there is no open market for the buying and selling of gold bullion, you’ll have to work with a dealer who may or may not give you the best price. It will also take some time to actually execute the transaction.
Paper Gold: Pros and Cons
Just like physical gold, there are advantages and disadvantages to paper gold.
Pros of Paper Gold
Paper gold has many advantages over physical gold, including the following:
- Liquidity: Unlike physical gold, paper gold can be bought or sold in a matter of milliseconds on the open market, in the form of gold mutual funds, gold ETFs or even gold mining stocks. You can see what the market price of your gold investment is at any time, and if you work with a zero-commission broker, you won’t even have to pay fees to buy or sell it.
- No added costs: You won’t have to pay for storage or insurance with your paper gold.
- No risk of theft: Although you can insure your gold, there’s always the chance that a thief gets their hands on your investment. With paper gold, there is nothing to physically steal, as your investment is just an electronic entry.
Cons of Paper Gold
Although the pros of paper gold are strong, there are also some drawbacks to owning it instead of physical gold. Consider these cons when comparing physical gold vs. paper gold:
- You don’t own any tangible gold: Although you own a financial asset that may correlate with the price of gold, you don’t physically own the actual product.
- Your investment may or may not own actual gold: Mutual funds and ETFs are overseen by portfolio managers. Depending on the limitations of the prospectus, your fund may not even own actual gold, perhaps substituting shares of gold mining companies instead. You’ll have to do some research to see what your paper gold is actually invested in.
- Market risk: Even if the price of gold is going up, your paper gold may trade down in value based on a number of market factors. These could include supply and demand, bad press or macroeconomic shocks.
- Expense ratio: Although you may not pay a commission to own paper gold, you’ll most likely have to pay ongoing annual costs in the form of an expense ratio. A fund automatically deducts various fees from funds to pay its managers, overhead costs, trading expenses and other charges, all of which reduce your total return.
Physical Gold vs. Paper Gold: How To Buy
To buy physical gold, you’ll have to go to a precious metals dealer. Choose a broker with a good reputation in the industry, low fees and reliable customer service. Avoid gold dealers that are too pushy or that try to sell you on investments that you don’t need or want.
To buy paper gold, you can usually work with a broker that already handles your other investments. As paper gold comes in the form of mutual funds, ETFs or even gold mining stocks, you can usually buy it on the open market, preferably through a zero-commission broker.
Which Is the Better Investment?
Physical gold and paper gold can be very different types of investments. Whereas physical gold will rise and fall in value with the gold market, you’ll pay dealer markups or fees both getting into and out of your positions. You may be able to avoid those costs with paper gold, but you’ll still pay annual expenses and there’s no guarantee that your fund will track the price of gold as closely as physical gold, even if it is a pure bullion fund.
This doesn’t necessarily make one type of gold investment better than the other. As each person’s financial situation, investment objectives and risk tolerance are different, the best investment for you might not be the same as it is for someone else.
One way to pick the right investment is to analyze what it is you want out of your gold, and what type of investor you are. Another option is to diversify by purchasing both physical and paper gold. Remember that whatever form of gold you pick, it should never be the only type of investment in your portfolio as a whole.
FAQHere are the answers to some of the most frequently asked questions regarding physical gold vs. paper gold.
- Is paper gold backed by physical gold?
- Your paper gold investment may or may not be backed by actual gold. Mutual funds and ETFs are overseen by portfolio managers. Depending on the limitations of the prospectus, your fund may not even own actual gold, perhaps substituting shares of gold mining companies instead. You'll have to do some research to see what your paper gold is actually invested in.
- Is it good to buy paper gold?
- Paper gold can be a good investment. It offers liquidity, no added costs and no risk of theft.
- Is it better to own physical gold?
- Physical gold is the most direct way to buy and own gold. It is easy to value but does come with some drawbacks like storage, markups and illiquidity.
- What type of gold holds its value best?
- Gold bars tend to hold their value and are quite popular with investors.