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Physical Bullion vs. Exchange-Traded Funds, What Investors Need to Know

etfs-bullion.pngEstimated reading time: 6 minutes

Investors have long utilized precious metals as a method of diversifying a retirement portfolio against inflation or the erosion of major currencies.  Over the last few decades, the price of gold and silver has increased in response to events that cause the value of paper money to decline. Yet, only in recent years have precious metals been made readily available to the masses through investment vehicles known as Exchange.

When looking to diversify a retirement portfolio into precious metals, investors now have two distinct options available to them. Retirement plans can hold precious metals in physical bullion form (bars or coins) or via electronically traded funds, better known as Exchange-Traded Funds (ETFs). It is important to understand the differences between these two options when determining which method is best for your self-directed IRA or 401(k). 

Precious metal ETFs, like GLD and SLV, are relatively new investment vehicles and have only been available to investors for the last 14 years. Precious metal ETFs were created to mirror the price of gold or silver. The “paper” option of holding precious metal ETFs is appealing to investors because of the ease of trading shares, which is very similar to the process of purchasing stocks or mutual funds.  The “management” and “transaction” fees of ETFs also tend to be lower than the cost of purchasing physical bars/coins. ETFs and mutual funds are also popular within employer-sponsored plans, as they are often the only option available to employees looking to diversify their 401(k)s into precious metals. 

One of the main drawbacks to  ETFs is that an investor is not actually purchasing physical metal. Rather, an investor owns shares in a fund that trends with the prices of a particular metal or commodity. For those individuals who prefer owning physical gold or silver, with the ability to one day take possession of their actual metal, purchasing physical bullion is the preferred choice. 

Investors also have the flexibility of investing their self-directed IRAs, or other retirement plans, into physical precious metals - including gold, silver, platinum and palladium coins and/or bullion. Unlike ETFs, the physical coins, bars, or rounds are purchased through a precious metals dealer of the IRA holder’s choice.  The assets are then stored by the self-directed IRA custodian in segregated accounts at a nationally recognized and regulated depository.  

The fees or commissions to purchase physical bars or coins will vary depending on the product being purchased and the dealer from whom the purchase is made.  The administration and custodial fees to hold and insure physical metal will vary depending on the IRA custodian, but usually run between $125 and $200 per year.  For many investors that choose to hold metal in physical form, the main benefit is the security of knowing you own the actual coins or bars. It is important to note that a self-directed IRA holder will be unable to take possession of these metals without penalties until the age of 59 1/2.

Knowing the difference between holding precious metals in physical or paper form is useful when deciding which of these two options is best for your retirement portfolio.  However, the reasoning for which you are diversifying into precious metals is almost as important - if not more so - as the purchasing method itself.  After nearly ten years in this industry, it has become clear that there are not only two distinct methods of purchasing precious metals, but there are also two distinct types of individuals that purchase gold and/or silver; those that are “investors” and those that are “protectors.” 

An “Investor” of precious metals is an individual who purchases gold and/or silver with the hopes that the asset will appreciate in value over time.  As with any investment, the goal is that the asset will increase in value over time and, in turn, increase the investor’s net worth. 

In the past, ETFs tend to be the investment vehicle of choice for those who wish to “invest” in gold or silver. They offer the ease of trading shares, as opposed to purchasing and holding physical bars or coins.  These vehicles do provide investors with a simple way of adding a precious metal component to their retirement portfolios, particularly in a 401(k) and other company sponsored plans. In recent months, online trading portals that allow investors to purchase physical bars or coins via their computers have also become popular.

On the other hand, a “protector “is someone who purchases physical metals with the intention of diversifying their portfolio or protecting their existing wealth.  These individuals view their gold or silver not so much as an investment, but more so as an insurance policy against inflation or a devalued currency.  History has proven that as a currency loses value due to inflation or other factors, the price of physical metal has increased against the devalued currency.  

“Protectors” not only use precious metals as a hedge in their retirement portfolios, but they tend to prefer to hold the actual bars or coins in the event they choose to take delivery of the assets.  With huge amounts of monetary stimulus being poured into the world markets over the last few years, there are real concerns that the increased money supply will eventually lead to inflation, if not hyperinflation.  Individuals looking to protect their existing wealth in the event of inflation or a devalued U.S. dollar ($) tend to choose physical metals, as opposed to ETFs.  After all, ETFs are a market instrument, and in a time of crisis, these funds may not provide the investors with the protection they originally sought.  

The recent pressure on gold and silver prices has only strengthened this theory of two distinct purchasers of precious metals. Those who have “invested” in precious metals have been fleeing leveraged gold and silver ETFs, causing the prices of both assets to pull back more than 30% in recent months. Yet, in the midst of this price pullback, demand for physical metals has reached an all-time high. On April 24th, the U.S. Mint announced it was suspending the sale of certain Gold American Eagle coins because of the increased demand and a depleted government inventory. At the same time, most retail dealers now have a 3-4 week delivery timeframe for all new silver orders, as silver bullion has experienced a similar supply crunch.  

When determining the best option for adding precious metals to your retirement plan, it is important to understand the difference between the two purchasing methods. However, it is arguably just as important to realize the reasoning behind your purchase in the first place. Which is the best option? That would depend on whether you are an "investor" of precious metals or a "protector" of your wealth. 

Entrust does not offer ETFs, however, for more information on holding physical bullions within a self-directed IRA, please visit our Precious Metals Center today. 

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