CHICAGO 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 percent, although you can find a fund charging as low as 0.25 percent. 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 U.S. interest rates in the U.S. will also hurt the metal's price.
Since gold is so volatile, do not invest more than 10 percent of your portfolio in it. You would need look no farther than last Friday for an example of the risk; gold fell nearly 2 percent -- 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 U.S. 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 percent annually for this service, which is just under the average for this kind of fund (0.54 percent). The fund is up 13 percent year to date and has risen 20 percent 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 percent. It has returned about 23 percent over the past three years through October 19 and 6.6 percent year to date. I hold this fund in my 401(k).
The iShares fund is gaining assets because of its initial cost advantage, which is a real plus for long-term holders like me. It holds more than $11 billion in gold and trades about 1.4 million shares daily.
That is because costs matter. Let us say you invest $50,000 in both funds and obtain an annual 10 percent return over 20 years. Due to the lower expense ratio for the iShares fund, you'd have $9,486 more than the SPDR fund over that period, according to the SEC Mutual Fund Cost Analyzer. This figure includes total fees and foregone earnings lost to expenses but not brokerage commissions to buy shares. In this basic cost analysis, the iShares fund comes out ahead for buy-and-holders.
With both of these funds, be aware that gold, like all metals prices, will continue to be volatile. There are no guaranteed returns or dividends that will be paid quarterly in all kinds of economic climates. It's worth watching how central banks, hedge funds and speculators regard the future of the metal. If they are not long-term buyers -- they were pulling back slightly last week -- gold prices may not breach the $1,800 level.
However you choose to label it, gold prices don't predict the future and certainly would not help you much if economies turn around. The metal pays an "anxiety premium" that moves inversely to the dollar's relative value. When you bet on gold, you are also betting on U.S. -- and often global -- economic fallbacks and inflation. It is still more like disaster insurance, only it will not fix your home after a catastrophe.
(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)
(Follow us @ReutersMoney or here Editing by Beth Pinsker Gladstone and Kenneth Barry)