4 Reasons Why Investors Should Avoid Gold ETFs

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ETFs are one of the most potentially lucrative investments that someone can make. In fact, the total value of ETF assets was approximately $4.4 trillion as of September 2017.

But, just like when preparing to make other investments, you need to know what you should put your money in and what to avoid.

While gold ETFs may seem like a great option considering the historical value that gold has had for over a century, they actually aren't the best decision to make when allocating money for investments.

Still on the fence about it? Don't worry, we've got you covered.

Let's take a look at why you should avoid this type of ETF and place your money elsewhere.

1. You Don't Actually Own Gold

The fact that investors don't even get to own any gold is brimming with irony.

People invest in gold so that they have a physical medium to back up the currency they used to make their investment. But, gold ETFs function almost identically to stocks and currency.

Rather than gaining access to physical gold, all you'll receive is a paper or online document that declares how much gold your investment is linked to. But, the gold you put your money towards is always in the hands of someone else.

Despite the fact that gold ETFs function more like stocks than actual gold investments, the government doesn't consider them stocks when it comes to taxation.

Instead, the government categorizes this type of investment as a "collectible," which is subjected to the same tax rules as owning physical gold. The problem here is that you pay the same taxes for an ETF as you would for gold bullion but don't have the physical metal to back up your currency.

Thus, you'll be experiencing an increased level of tax liability for no reason when choosing a gold ETF over the metal itself.

2. ETF Fees

As previously mentioned, you won't actually gain ownership of physical gold with this type of ETF.

With gold, you'll encounter fees when making your purchase but you'll have full ownership afterward. With gold ETFs, however, you'll be hit with charges for the entire life of your investment.

Fees related to marketing and management are constant expenses that you'll have to deal with. But, you'll also need to pay taxes when you decide to sell your fund. Much to the dismay of investors, this applies any time you sell your gold ETF, as the government considers this a taxable event. As you can imagine, this often defeats the purpose of investing money in a gold ETF in the first place.

The longer you hold this type of fund, the more money you'll lose in comparison to owning physical gold. Unlike an investment in something like a steel company, the gold you're investing in doesn't generate any income. This leaves you constantly paying for the maintenance of your investment.

Thus, you should take this into consideration if you're on the fence about whether or not to invest in gold ETFs.

3. Counterparty Risks

Yet another issue with being denied access to physical gold despite your investment is the risk you assume when you trust someone else to make sure your investment is properly secured, managed, and insured. To make things worse, there are multiple people involved in managing ETFs, which only increases the likelihood that something goes wrong with your investment.

For example, ETF iShares Gold Trust failed to register with the Securities and Exchange Commission (SEC) in 2016, which resulted in the firm having to deny any investors who wanted to secure new shares. This type of management error is something that simply shouldn't be a factor when investing. iShares Gold Trust is one of the more attractive options when it comes to securing gold ETFs, and it still puts investors at risk.

This creates a scenario where investors are essentially hoping that the statement they receive about their gold ETF investment is true, especially since they'll never get to see any of the gold they've supposedly invested in.

4. Significant Market Risk

As if there weren't enough issues to consider, gold ETFs have a notable market risk for investors.

And these risks often have nothing to do with the actual value of gold bullion. Instead, they depend on the ETF company itself. 

By reading a company's prospectus, you'll gain insight into just how many risks are at hand. One of the most common dangers is asset liquidation, which can occur due to a handful of factors, such as:

  • The firm's balance falls below a certain amount
  • An agreement by at least two-thirds of the firm's shareholders
  • The firm's net asset value falls below a certain amount

This type of volatility makes gold ETFs an investment that can fall through in worst-case scenarios. While this is true for any investment, the number of factors at play drastically increases the chance of this scenario.

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