When the United States news stations begin reporting rising inflation rates, many people look to gold and other precious metals as insulators against inflation. This action may be fueled, at least partly, on the erroneous belief that American currency is backed by gold stored somewhere at Fort Knox; however, that idea is no longer accurate. So, while investing in precious metals mutual funds is a viable option, we must determine if it is the most profitable option.
Precious metal mutual funds may seem like a good investment because most people think it offers protection against inflation. However, as all countries have gone off the gold standard, this is no longer true. Moreover, prices of precious metals can fluctuate and investors cannot expect guaranteed returns.
The rest of this article will explain a few concepts related to this question, including a review of how mutual funds investments work. We’ll also discuss why many investors believe precious metals are a good investment, reasons to avoid precious metals mutual funds, and better options for mutual funds investing.
Table of Contents
Basics of Mutual Funds
Mutual funds are vehicles that investors use when they pool their money to purchase different securities. These funds make diversification easier, have fewer costs, and are convenient.
What beginning investors may not know is that mutual funds focus on several distinct options with varying investment types and goals.
Let’s review some fund types before getting into why precious metals mutual funds may not be the best investment today.
- Bond Funds invest in government and corporate bonds. These funds are generally fixed-income securities.
- Growth Funds seek investments with companies that show above-average growth.
- Index Funds attempt to track the market index and construct a portfolio that meets or beats that index.
- Sector Funds focus on a specific industry or sector of the economy, such as precious metals.
- Value Funds focus on companies that are undervalued. These funds are long-term investments.
When looking at these fund types, it is easy to determine at least one area of caution: precious metals mutual funds may not be a good investment today because they are sector funds with negligible economic diversification and high volatility.
To explain, while the precious metals mutual fund itself may offer diversification by investing in several different companies, all of those companies will be tied to precious metals in some way. Therefore, the entire fund is based on just that sector.
In contrast, growth funds seek companies that reinvest earnings back into themselves for things like research and development, real estate, and expansion, with the goal of capital appreciation.
While one or more of the companies in a growth mutual fund may be in the precious metals market, other companies in that same fund will not be tied to precious metals, which means more diversification and less risk.
How Do Precious Metals Mutual Funds Operate?
To some, investing in precious metals mutual funds seems like a good idea because many argue that precious metals investments can offer a hedge against inflation. This idea may have been true decades ago, but that idea is not as valid today as you will read later.
Also, suppose a large portion of your portfolio is invested in precious metals mutual funds. In that case, you may be headed for trouble, particularly if you do not know how your specific mutual fund operates.
One way precious metals mutual funds operate is by investing in physical assets, such as gold or silver. This option is suitable for those who want to own gold or other precious metals but do not have a vault to store them.
The main reason investing in precious metals mutual funds is not a good idea right now because of the second way these funds operate.
If the investment is not made in physical assets, as described above, the investment is trading futures, which is extremely risky and expensive.
In addition, the writers at MutualFunds.com explain that risks are amplified, which means even a slight decrease in the metal’s price could result in enormous losses for the mutual fund.
Further, the mark-to-market accounting methodology makes the investment even riskier. Writers at MutualFunds explain this risk well. They present this methodology as, “…positions are closed out and tallied at the end of each business day so even if you correctly predict where gold or silver prices end up at, a single day in correction could mean that your entire investment is lost.”
While precious metals mutual funds work differently in that they are not entirely a futures portfolio, and as such, they would undoubtedly offer less risk, these funds still contain futures contracts.
In other words, you likely will not lose your entire investment if you own a precious metals mutual fund, but your portfolio is at a higher risk than it has to be.
Why Are Precious Metals Often Considered a Good Investment?
One of the main reasons people are interested in precious metals is because many erroneously believe that the global economy is backed by gold and other precious metals, which has not been the case for many countries for over 50 years.
In fact, no government uses the gold standard today, and America followed Britain and stopped using the gold standard in 1933.
Countries replaced the gold standard with fiat money which, in essence, says the country’s currency is backed by the government’s order or word, but not by anything tangible—gold or otherwise.
Therefore, while gold, silver, and other precious metals remain valuable and highly sought after, they are not what they were during the days of the California Gold Rush.
Precious metals are valuable today because of the things they are used in, such as computer parts, dental appliances, and medicine, but not because they back the entire world’s economy.
Reasons Not To Invest in Precious Metals Mutual Funds
Although investing in precious metals mutual funds makes owning gold easier than panning a river for it or finding a place in your home to store solid bricks, it is still not the best option for now for several reasons.
- Because America no longer uses the gold standard, your portfolio will not be insulated from inflation just because you own a stake in a precious metals mutual fund.
- The prices of gold and silver, among other precious metals, are volatile.
- Precious metals prices, particularly gold, are historically based on emotion, which is fickle at best.
- Even if the economy bursts and inflation hits an all-time high, a bag full of gold will not buy you any more food than a fist full of money. Both are only as valuable as the trust the public places in them.
Better Investment Opportunities
Investing in any company or commodity has inherent risks, but it does not mean you should not invest your money so that it can grow to your point of need. However, you must make educated decisions about those investments.
Rather than investing in precious metals mutual funds right now, consider mutual funds that focus on real estate or technology. Medicine is also a good bet much of the time as well.
Do not forget to create equity in your home and fully fund any 401K that your employer provides. Most 401Ks have a healthy mix of stocks, mutual funds, and other investments, but investors overlook this significant benefit as they seek to build their financial portfolios.
Conclusion
Suppose your investment portfolio is diversified with stocks, bonds, mutual funds, and real estate from many sectors. In that case, you will be far more insulated against inflation than if you focus on precious metals. The bottom line is that investing in precious metals mutual funds is likely to produce more angst than profit.
