What are Gold Funds?
28/11/2024Daniel Fisher
Gold has long been a symbol of wealth and a trusted investment choice, especially during times of economic uncertainty. Its enduring value makes it a popular addition to investment portfolios to help provide balance and security. Today, there are many ways to invest in gold, from purchasing physical gold to exploring more modern options like gold funds.
Gold funds, in particular, have gained traction as a convenient and accessible way to invest in gold without the hassle of owning and storing it. Whether you’re a seasoned investor or just starting out, understanding what gold funds are and how they work can help you decide if they’re the right fit for your financial goals.
In this post, we’ll break down everything you need to know about the various gold funds, how they differ from other gold investments, and why they could be a smart choice for diversifying your portfolio.
What Are Gold Funds?
Gold funds are a modern investment vehicle that provides an easy and hassle-free way to invest in gold. They eliminate the need for physical storage and offer a convenient option for individuals looking to include gold in their portfolio without directly purchasing it.
Definition of Gold Funds
Gold funds are investment funds or exchange-traded funds (ETFs) that focus on gold or gold-related assets. Instead of buying physical gold like coins or bars, investors can put their money into these funds, which track the performance of gold prices or companies associated with the gold industry.
These funds are managed by specialist fund managers who allocate investments strategically, ensuring that they align with the underlying goal—offering returns that mirror the movement of gold prices. Essentially, gold funds make it easy for anyone to invest in gold without worrying about its physical handling or security.
Types of Gold Funds
Gold funds come in different forms, each tailored to meet various investor needs and preferences. The nuances of each provide very different market and risk exposure, and variance in performance.
1.Physical Gold-Based Funds
These funds invest in actual gold bullion reserves or securities backed by physical gold. The fund’s value closely tracks the price of gold in the market, offering investors a direct way to benefit from gold price fluctuations. This option suits investors wishing to have electronic exposure to real gold prices.
2. Gold Mining Funds
These funds focus on companies involved in the extraction, processing, and production of gold. Their performance is influenced by both gold prices and the operational success of the mining companies. While they can offer higher returns, they also carry additional risks related to the mining industry.
This option is attractive to investors seeking exposure to gold mines but who wish to spread their risk amongst a pool of different gold mining operations. The fund manager may select mining companies across various mining methods, locations, and development stage.
3. Gold ETFs (Exchange-Traded Funds)
Gold ETFs are a popular choice for investors who want the flexibility of stock market trading combined with exposure to the gold price. Each unit of a gold ETF typically represents a certain amount of gold, making it easy to buy, sell, or trade just like any other stock.
Each type of gold fund has its own set of benefits and risks, allowing investors to choose based on their goals, risk tolerance, and investment strategy.
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How Do Gold Funds Work?
Making money from owning physical gold coins and bars is a straightforward concept. Buy the piece of gold at one price, wait for gold to appreciate in value, then sell it at the higher price. But how do the mechanics of gold funds work?
By pooling money from multiple investors, these funds are managed by professionals who strategically allocate assets to provide returns closely linked to the price of gold or gold-related investments. Here’s a closer look at how they operate.
The Structure of Gold Funds
Gold funds are structured as open-ended investment companies (OEICs) or exchange-traded funds (ETFs), with the goal of mirroring the performance of gold. Fund managers typically invest in one or more of the following:
- Physical gold: Reserves stored securely in vaults.
- Gold futures or derivatives: Contracts based on future gold prices.
- Gold mining companies: Stocks or bonds of businesses in the gold industry.
This structure allows investors to benefit from the movements in gold prices without direct involvement in managing physical gold. The fund’s assets are held in a diversified portfolio to reduce risks while maximizing potential returns.
Tracking Gold Prices
Gold funds’ performance is heavily influenced by the price of gold in the global market. When gold prices rise, the value of the fund typically increases, and when prices fall, the fund’s value may decline.
- Gold ETFs: Usually track the price of gold very closely, as they are directly backed by physical gold or derivatives.
- Gold mining funds: Their performance is indirectly linked to gold prices, as factors like company operations and market conditions also play a role.
This price-tracking feature makes gold funds a reliable way to gain exposure to gold’s market movements.
Buying and Selling Gold Funds
One of the key advantages of gold funds is their liquidity and ease of transaction:
- For Gold ETFs:
- These can be bought and sold on stock exchanges, just like shares of a company. Investors can trade throughout the market day at real-time prices.
- A brokerage account is required to invest in ETFs.
- For OEICs:
- Investors purchase units of the fund directly from the asset management company, often at the day’s net asset value (NAV).
- OEICs, also referred to as mutual funds, are better suited for long-term investors who are less concerned with daily price fluctuations.
Whether you prefer the flexibility of daily trading or a longer-term investment approach, gold funds cater to a range of investment styles and objectives.
Benefits of Investing in Gold Funds
Gold funds offer a range of advantages that make them an appealing option for investors. From convenience to affordability, these benefits allow investors to access gold markets without the challenges of traditional gold ownership.
No Need for Physical Storage
Investing in gold funds eliminates the need to store physical gold securely. Unlike gold bars or coins, which require safes or bank lockers, gold funds exist in electronic form. Of course, most physical gold dealers will offer professional vaulting services, but this represents an additional cost to investors. Gold funds offer:
- Convenience: No logistics involved in storing or insuring physical assets.
- Security: Reduced risk of theft or damage, as the gold is managed by professional institutions.
With gold funds, investors gain exposure to gold’s value without the worry and cost of handling physical assets.
Liquidity
Gold funds are highly liquid and easier to trade compared to physical gold.
- Gold ETFs: These can be bought or sold on stock exchanges at any time during trading hours, providing flexibility.
- Physical gold: Liquidity of well-known gold coins and bars is superb, with sales being possible within a day or two. But there can still be the challenge and cost of moving the gold moving the gold items to the buyer. Selling collectible coins or bars often requires finding the right buyer, which could take weeks or months.
This ease of buying and selling ensures that investors can access their funds whenever needed, without delays.
Portfolio Diversification
Gold funds serve as an effective tool for diversifying investment portfolios.
- Hedge Against Inflation: Gold traditionally retains its value during periods of rising inflation, making it a safe haven.
- Economic Uncertainty: Gold often performs well during economic downturns, providing stability when other investments falter.
By including gold funds in a portfolio, investors can reduce overall risk, iron out volatility, and add balance.
Low Initial Investment
Unlike physical gold, which may require a significant upfront purchase, gold funds are more affordable. As gold prices continue to increase, the minimum investment amount of physical gold also grows, as the price of the smallest available bar or coin rises. But units in a gold fund provide accessibility comparable to buying a fractional amount of a gold bar.
- Investors can start with small amounts, making it easier for beginners or those with limited capital to participate.
- This accessibility allows individuals to benefit from gold’s price movements without needing large reserves of cash.
- This is particularly conducive to those wishing to adopt a regular Dollar Cost Averaging (DCA) strategy.
Convenient Consolidation
Gold funds are typically offered by asset management companies that also provide access to other investment options, such as stocks, bonds, and mutual funds.
- Investors can consolidate their investments in one place, like a retirement account or pension.
- This simplification makes managing a diverse portfolio more convenient and efficient.
Easier to Track Value
Many gold funds provide access to online portals where investors can monitor the value of their holdings 24/7.
- Real-Time Updates: Investors can track daily performance without waiting for appraisals or market reports.
- Transparency: Online tools provide clear insights into fund performance, helping investors make informed decisions.
- Automated Purchases: Repeated investments on a set frequency can easily be automated with most gold funds. This allows investors to accumulate their holding without the manual process of repeated transactions.
This accessibility ensures that investors stay informed about their investments at all times.
Access to Gold Derivatives
Some mutual funds invest in gold derivatives, such as gold futures and options, providing exposure to more sophisticated financial instruments.
- Enhanced Returns: Gold derivatives allow investors to profit from short-term price movements.
- Diversified Strategy: By including derivatives, these funds offer opportunities that go beyond physical gold’s performance.
This advanced investment option can be particularly appealing for those with higher risk tolerance or a more active investment strategy. Gold derivative funds reduce the burden of expertise required when trading directly into such complex instruments.
Risks and Considerations
While gold funds offer numerous advantages, they also come with certain risks and considerations that investors should be aware of before committing their money. These can relate to gold as an asset class, or more specifically to the fund structure and exposure. Understanding these factors will help you make informed decisions aligned with your financial goals.
Market Risks
The value of gold funds is heavily influenced by fluctuations in gold prices, which can be volatile.
- Price Volatility: Gold prices are affected by global economic conditions, interest rates, geopolitical events, and currency fluctuations. A sudden dip in gold prices can impact the returns on your investment.
- External Factors: Events such as policy changes or shifts in demand for gold in key markets can also affect fund performance.
Investors should be prepared for periods of instability and consider their risk tolerance before investing. While gold prices have risen throughout history, it’s important to remember that just like with stocks, gold prices can fall in value. The wisest strategy is usually to spread risk between gold and other well-researched asset classes.
Counterparty Risk
Gold funds are managed by professional institutions, which introduces risks related to the performance and stability of these entities.
- Fund Management Risk: There’s a risk that the fund management company may underperform, make poor investment decisions, or mismanage assets, leading to lower-than-expected returns.
- Gold Mining Stock Risk: Funds that invest in gold mining companies face the additional risk of company-specific issues, such as operational failures, declining reserves, or poor management. If a mining company in the fund’s portfolio goes bankrupt, it could significantly impact the fund’s overall value.
Investors should assess the reputation and track record of the fund management company and consider the inherent risks in mining-related investments.
Fees and Expenses
Investing in gold funds isn’t free and often comes with associated costs:
- Management Fees: Mutual funds and ETFs typically charge annual expense ratios, which can eat into your returns over time.
- Brokerage Fees: For ETFs, trading on exchanges may incur brokerage charges, adding to the cost.
- Other Costs: Some funds may have additional charges for services like portfolio management or redemption fees for early withdrawal.
It’s essential to review a fund’s fee structure and compare it with its potential returns to ensure it aligns with your investment objectives. Not all funds charge the same, so shop around and weigh up costs versus performance.
Long-Term vs. Short-Term Investing
Gold funds can suit different investment timelines, but each approach has unique challenges:
- Short-Term Investing:
- Ideal for those looking to capitalize on quick price movements.
- However, short-term gains are often subject to higher taxes, and frequent trading can incur additional costs.
- Long-Term Investing:
- Helps offset short-term market volatility, as gold tends to hold its value over extended periods.
- Investors must be patient, as long-term returns might lag behind those of more aggressive investments like equities.
Choosing the right investment horizon depends on your financial goals, risk appetite, and market outlook.
How to Start Investing in Gold Funds
Getting started with gold funds in the UK is a straightforward process, but it’s important to approach it with a clear plan. From selecting the right fund to choosing the best investment platform, base your choices on those which meet your personal investment objectives.
Choosing the Right Fund
Selecting the right gold fund is a crucial step, as it impacts your returns and aligns your investment with your financial goals. Here are key factors to consider:
- Fund Type: Decide between gold ETFs, OEIC funds, or funds focusing on gold mining stocks. ETFs may suit short-term traders, while mutual funds or mining funds may appeal to long-term investors.
- Performance History: Look at the fund’s historical performance to understand how it reacts to market changes. While past performance isn’t a guarantee of future returns, it provides useful insights.
- Expense Ratio: Compare management fees and other associated costs. A fund with high fees could erode your returns over time.
- Risk Profile: Assess whether the fund aligns with your risk tolerance. Funds invested in gold mining stocks may be more volatile than those backed by physical gold.
- Fund Manager Reputation: Research the track record of the fund management company. Well-established firms like BlackRock, Vanguard, and Fidelity often offer gold funds to UK investors.
Investment Platforms
In the UK, a wide range of platforms allows investors to buy and manage gold funds easily. Selecting the right platform depends on your preferences and investment style.
- Online Brokers: Platforms like Hargreaves Lansdown, AJ Bell, and Interactive Investor provide access to a variety of gold funds, including ETFs and mutual funds.
- These platforms often feature tools for research, comparison, and tracking performance.
- Fees typically include platform charges and trading commissions, so compare costs before choosing.
- Stock Trading Apps: Apps such as eToro and Freetrade cater to beginner investors with user-friendly interfaces and access to gold ETFs.
- Many apps offer commission-free trading, making them cost-effective for smaller investments.
- ISAs and SIPPs: Consider investing in gold funds through a Stocks and Shares ISA or a Self-Invested Personal Pension (SIPP).
- ISAs allow you to invest up to £20,000 per year tax-free, while SIPPs provide tax benefits for retirement savings.
- Many platforms, like Nutmeg or Vanguard, integrate gold funds into their ISA and SIPP offerings.
- Financial Advisors: If you’re unsure about where to start, consulting a financial advisor can help. Advisors in the UK can guide you through fund selection and platform setup based on your individual circumstances.
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Gold Funds vs. Physical Gold: Which Is Right for You?
Deciding between gold funds and physical gold depends on your investment goals, risk tolerance, and practical considerations. Both options provide exposure to the value of gold, but they differ significantly in terms of storage, liquidity, taxes, potential returns, risk, and costs. While some investors simply want the comfort of owning real tangible physical gold, others spread allocation between various gold investment methods.
1. Storage and Insurance
- Gold Funds: No storage or insurance is required. Your investment exists in electronic form and is managed by professional institutions, offering convenience and peace of mind.
- Physical Gold: Requires secure storage, such as a home safe, safe deposit box, or professional gold vaults. Insurance costs add an extra layer of expense to protect against theft or damage. Those storing modest amounts of gold at home find they can gain insurance cover with their current home insurance provider. We charge customers 0.5% + VAT semi-annually to store and insure their gold in specialist vaults.
Who Might Prefer This?
Investors who value convenience and simplicity may prefer gold funds, while those who want tangible assets they can physically own, know you can’t beat having physical gold in hand.
2. Liquidity
- Gold Funds: Highly liquid, especially ETFs, which can be bought and sold on stock exchanges during trading hours.
- Physical Gold: Mainstream bullion coins and bars are highly liquid. Selling physical gold, especially collectible coins, may require finding the right buyer, which can take time.
Who Might Prefer This?
Gold funds suit investors looking for quick and easy transactions. Physical gold can also be converted in cash quickly but with the added layer of having to physically transfer the gold to the buyer.
3. Tax (VAT, CGT, and Dividend Tax)
- Gold Funds: In the UK, gold funds are subject to Capital Gains Tax (CGT) when you sell for a profit, but no Value Added Tax (VAT) applies. Tax will also be applicable if a fund pays out dividends. Tax efficiency may be achieved if the gold fund can be held within a tax-free shelter such as a pension or Individual Savings Account (ISA).
- Physical Gold: Investment-grade gold bullion is VAT-free in the UK. Certain gold coins, such as Sovereigns and Britannias, are also exempt from CGT, offering significant tax advantages for UK investors. Additionally gold bars of 99.5% purity or higher also qualify for a Self-Invested Personal Pension (SIPP)
Who Might Prefer This?
UK investors looking for tax-efficient options may lean towards physical gold coins, while those unconcerned with taxes may find gold funds more convenient. For those focussed on having gold exposure within their pension, gold funds may provide flexibility to add these into a wider range of pension types, while gold bullion can only be held within a SIPP.
Inheritance tax is payable on both physical and electronic gold assets, but the private nature of physical gold transactions appeals to those with inheritance tax concerns.
4. Upside Potential
- Gold Funds: Returns typically mirror the price of gold or gold-related assets. However, mining stock funds may offer additional growth potential if the companies perform well.
- Physical Gold: Some coins, especially collectible or rare coins, may appreciate beyond the underlying gold price due to their rarity and demand.
Who Might Prefer This?
Investors seeking predictable exposure to gold’s market price may prefer gold ETFs, while those interested in potentially higher returns from rarer coins might opt for physical gold.
5. Risk (Counterparty and Market)
- Gold Funds: Counterparty risk exists as you rely on the fund management company’s performance. Market risk affects all gold-related investments due to price volatility.
- Physical Gold: There’s no counterparty risk since you own the asset outright. However, market risk still applies, as the value of gold can fluctuate.
Who Might Prefer This?
Investors wary of counterparty risk will always favour physical gold, while those comfortable with professionally managed investments may prefer funds.
6. Cost (Bid/Offer Spread vs. Management Fees)
- Gold Funds: Typically involve annual management fees or expense ratios, which can range from 0.1% to 1%. ETFs may also incur brokerage fees when trading.
- Physical Gold: The bid/offer spread (the difference between buying and selling prices) can be significant, especially for collectible. Additional costs include storage and insurance. Gold premiums can be reduced substantially by focussing on more generic coins and buying in larger quantities. Our range of best value coins provide physical gold at low margins.
Who Might Prefer This?
Short term investors and those wishing to actively trade the gold market will almost certainly benefit from the smaller spreads involved in electronic ownership. Longer term “buy and hold” investors realise that larger spreads for owning the real thing can be overcome easily over time.
Conclusion
Who Should Choose Gold Funds?
- Ideal For:
- Investors seeking convenience and easy access.
- Those who prefer liquidity and frequent trading.
- Individuals looking to avoid the complexities of storing and insuring physical gold.
Who Should Choose Physical Gold?
- Ideal For:
- Investors who value tangible assets they can physically own.
- Those looking for tax-efficient options like CGT-exempt coins in the UK.
- Collectors or long-term holders seeking rare coins with higher upside potential.
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FAQs
Are gold funds safe?
Gold funds are generally safe investments, offering exposure to gold without owning physical metal. They are backed by gold or track gold prices, providing stability during economic uncertainty. However, they carry risks like market fluctuations and fund mismanagement.
Can I lose money in gold funds?
Gold funds such as ETFs track the price of gold. As such, capital invested can fall in value if the gold price falls. Investors should also factor in the ongoing cost of fund management fees. Funds tied to gold mining stocks are deemed riskier as they have exposure to individual company performance.
What is the best fund to buy gold?
The best gold fund depends on your goals. SPDR Gold Shares (GLD) is a popular option, backed by physical gold and offering low expenses. For diversification, consider iShares Gold Trust (IAU) or funds investing in gold mining stocks for higher risk and potential returns. Always review fees, performance, and investment objectives before choosing.
What is the difference between a gold fund and a mutual fund?
A gold fund focuses on gold or related assets, like bullion or mining stocks, offering exposure to gold prices. A mutual fund is a US term, like the UK OEIC, which invests across diverse assets, such as stocks or bonds, for broader diversification. Gold funds are less volatile but depend on gold prices, while mutual funds vary in risk based on their asset mix and market performance.
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