Gold Mutual Funds vs. Gold ETFs: Depends on the Goal

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"The decision can mean a big difference in returns."

Mutual-fund investors pondering adding gold to their portfolios have an important choice to make: Should they buy a fund that owns gold-related stocks or an exchange-traded fund tracking the price of gold?

The decision can mean a big difference in returns.

At first glance, this year's returns point to stock funds as the clear winner. The average precious-metals stock fund is up 37%, according to Morningstar, while SPDR Gold Shares are up 19%.

Gold-related stocks, which are predominantly mining companies, "are a leveraged play on gold," says Joseph Foster, a portfolio manager for Van Eck International Investors Gold.

If it costs a company $800 to mine an ounce of gold, and gold is $1,000 an ounce, the company's profit is $200. If gold rises to $1,100, the profit becomes $300. That's a 50% rise in profits off a 10% rise in the price of gold.

Gold stocks have, over time, tended to move twice as much—up or down—as the price of gold.

Of course, there are other factors at work with gold stocks and the funds that invest in them. Companies can run into production or financial issues. Stock-fund managers can make bad picks.

The bigger issue is, simply, that these are stock funds. If the stock market goes into a free fall, gold stocks get sucked into the downdraft.

So, to have part of the portfolio act as an insurance policy, the ideal investment is one that smoothes out overall returns and doesn't make things worse. In that case, the better option may be gold ETFs, such as the SPDR or iShares Comex Gold Trust.

If the investment premise is that gold is in the midst of an extended bull market, then gold stocks may be the better choice.

Of course, the risk with gold stocks is that gold prices in fact decline and that bang turns into an implosion.

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