Investing in the 79th Element

Gold, the 79th element in the periodic table, is perhaps the most controversial of any investments.  Every investor seems to have an opinion on the metal.  Some people, particularly enamored with the constitution, read into it the necessity for the government to only issue gold (and silver) coins.  So, investing in gold… is it a good idea in your portfolio?

Regardless of your viewpoint on the legality of fiat currency, perhaps you have decided to take the plunge and invest some of your hard earned funds into the stuff.  There are many ways to approach investing in gold; I will lay out a few approaches to gold investing in this article.

A Brief, Contentious Historical Summary of Investing in Gold

The United States has historically altered between being backed by gold at a fixed rate or a constant rate. Two major events in the history of our currency are pointed at as the most controversial laws our nation has passed with regards to gold and silver backed currency.  The first is the “Gold Confiscation Act”, or Executive Order 6102 under President Franklin D. Roosevelt.  That act banned the ‘hoarding’ of gold over the amount of $100 for private investors.  The second was the August 15, 1971 act by President Richard Nixon to depeg the $35 / oz. gold standard due to excessive spending on Vietnam and President Lyndon Johnson’s ‘Great Society’.  Since 1971, currencies of the world have been fiat currencies, and the rate of gold exchange is set by the market.

Widely Held Beliefs on Investing in Gold

Just because beliefs are widely held doesn’t mean they accurately reflect reality.  Yes, there is a correlation between the devaluation of the dollar and the increase in the price of gold (it is not 100%, stocks are a better inflation hedge).  However, gold tends to perform even better in times of deflation (see here and here).  Gold’s highest performance potential would seem to be linked to an emotional event rather than a monetary one.  Gold has historically been used as currency, and its perception as currency might keep it valuable in times of great emotion.

Whatever The Reason…

Investing in gold isn't like investing in copper pennies...
Picture of copper… I guess it’s similar to gold

Regardless of the reason why you want to purchase gold, you have decided to take the plunge.  The next step you have to consider is how, exactly, you are going to go about that.  There are a few options for you to invest in the metal, which I will highlight shortly.  It is important to note, that for whatever reason, gold is considered a ‘collectible’ by the IRS.  This means that no matter your holding period, physical gold capital gains you receive will actually be taxed at your marginal rate.  See a tax professional for more details… I am not one.

Pick a Door

  1. Physical Bullion – Depending on your risk tolerance, (and possibly, paranoia) physical gold is an option.  You can buy gold coins, such as the popular American Eagle or the South African Krugerrand, for your own personal storage.  You’re going to want a safe… theft is probably the greatest risk to your gold holdings, not confiscation.  Alternatively, you could store it in a bank safety deposit box or off site in a vault like with Bullion Vault.
  2. Gold ETFsA much simpler solution is to invest in a gold exchange traded fund such as IAU and GLD.  You can even go long 2x the spot price of gold with an ETF such as [[UGL]].  There are a number of other options, check them out.  An ETF like GLD will hold physical gold somewhere.  Commodity ETFs are an interesting approach to investing in commodities in general, not just gold.
  3. Gold Stocks – Gold miner stocks, such as companies like Freeport McMoran FCX and Gold Fields, Inc. GFI are another way to play gold.  Gold stocks will not correlate perfectly with the spot price of gold, but will realize a benefit.  The nice thing about gold stocks (other than the reduction in tax if held in a taxable account for a sufficient duration vs. the ‘collectible’ tax of gold) is they won’t lose as much money on the way down if gold loses its luster.
  4. Derivatives – For a more exotic approach (where you can also apply leverage) to investing in gold you can check out the derivative market.  You can buy or sell options on gold, and invest in futures contracts.

Finishing it Off

All of these options are a solid bet for investing in gold.  Various options have their own advantages and disadvantages.  In a true crisis environment, physical gold would probably be better than any of the other options.  However, that sort of situation seems unlikely.  In a taxable account, ETFs are the most accessible way to invest in gold.  Take a look at CEF, which is the Central Fund of Canada (note CEF also holds silver).  In a taxable account, you can save money over the other options.  Of course, you could stick it in a retirement account and not worry about taxes.

Full Disclosure: That’s what I did; I’m invested in a mutual fund that invests some of its assets in physical gold in a tax-free account.  Consult a financial advisor if you have any questions.

ESPP – The Worldwide Leader in Returns

An Employee Stock Purchase Plan (or Program) is an interesting form of compensation offered by some companies which allows participants to purchase company stock at a discount to market price.

A common purchase discount for an ESPP is 15% of the market value on the either of two days: The first day money is locked up (known as the ‘lookback’ date) of a 6-month period, and the last day of the cycle.  Two 6-month cycles make up the average ESPP, and each cycle locks up your money for the entirety of that period.

How does that translate to the bottom line?

Say a person is making $100,000 a year – $90,000 in base pay and $10,000 in bonuses.  They can contribute up to 10%, or $10,000 into the ESPP.

Base Pay:                         $90,000
Bonus Pay:                      $10,000
ESPP Contribution:       -$10,000

Net Cash (Pre-Tax)        $90,000

Say the price of stock on the 20th is $20.00 a share:

If the price stays steady until February:
588 shares purchased, market value $11,760

If the price declines to $15.00 a share:
784 Shares purchased, market value $11,760

If the price increases to $25.00 a share:
588 shares purchased, market value $14,700

Total salary: $101,760, $101,760, $104,700.  This person effectively got 1.76% (or even 4.7%) raise, just by participating… not too shabby.

Can you lose money in an Employee Stock Purchase Plan?

The employee stock purchase plan: not using it is like a money fire
Don’t have this happen to you.

Of course… everything in investing has risk.  Two specific scenarios stick out in the risk consideration:

1)    Your employer can go bankrupt while holding shares (especially during the ‘float’ between the grant and the shares being available to sell, referenced below).  Reference Arthur Andersen, MCI Worldcom, Enron, Bear Sterns, Countrywide Financial etcetera for stories of what happens in that case.  Yes, you now have bigger problems than stock losses.
2)      If you decide to hold your shares, the stock price can continue to decrease AFTER the stock is purchased.  Of course, you are continuing to purchase every 6 months, so your exposure is cut by the fact you are averaging down.  If you sell immediately, you can avoid this to a degree.

What does a declining stock price mean?

Basically, a declinging stock price means more shares for you in an employee stock purchase plan.

Of course, you can sell immediately and take out all the risk to lock in a 15% profit.  Or, alternatively, you can let it ride (and infinite other combinations).  However, may I suggest selling immediately?

A key thing to consider in holding onto your ESPP shares is single company risk… if you work at a company that isn’t doing well, not only are your savings (in the form of ESPP granted company stock) at risk, but so is your very employment.  You should practice diversification… sell immediately and invest your money elsewhere.  However, if you think that you would invest in your company assuming you had free reign to pick to invest anywhere… then by all means, leave your stock in the account.


Full tax advantages of holding onto ESPP shares take two years to take effect.  Any sales before two years are considered a ‘disqualifying distribution’, and the difference between the price you paid and the fair market value on the purchase date is considered income.  The difference between the price at the time of sale and the cost basis (market value on the purchase date) will be treated as normal capital gains or losses.

There is one case where a large amount of damage can be done.  As detailed at this site, if the price of the stock increases greatly between the lookback date and the final date, that difference will have to be reported as income regardless of the selling price!  If you end up selling the shares for less than the lookback date’s value, you will owe tax on the income you WOULD have earned had you sold immediately.  In this case, ensure you hold onto your shares for two years.

Second, 15% is the discount on the date of the stock grant.  Between the date of the grant and the shares actually hitting your brokerage account, lots of things can happen.  The stock price can go down, (or even to zero, theoretically) up, and stay flat.  This has to be considered in any discussion of ESPPs.

More Math on the ESPP…

A 15% discount translates into a 17.6% gain, just for participating (1 / .85).  However, your actual gain and annualized gains are much better than that.

Say you get paid every week, and $100 goes into your ESPP:

$100 * 26 = $2600

Your shares are worth $3058.82, for a gain of $458.82.  On the surface, you made ~17.6%.  However, look closer.  You made 17.6% on a 6 month lockup of your money…. but your money (because of the timing of your paychecks) was only locked up for an average of 3 months.  Annualized, this works out to a ~ 90% annualized gain! (1 * (1.176^4))

That’s tough… or impossible… to beat with ANY investment.  Also, this is the minimum (other than the ‘float’ discussed above) that you can possibly earn.  An employee stock purchase plan can feel like a money printing press.

Conclusion: Sign up for the ESPP Today!

The only real downfall to the program is your money is locked up for 6 months.  In 6 months this money will be free to leave in your brokerage or sell, and the next participation period won’t affect you (since the current period’s money will be available).  It really will only affect you the first 6 months… so get it over with.  You can either sell at that point, or leave it in, but either way you’ve given yourself a raise.

My suggestion?  For the vast majority of employers you should max out your employee stock purchase plan… and sell immediately.  It’s not worth the uncertainty of waiting for favorable tax treatment, where a small decline can wipe out any gains you got from waiting for the lower tax rates.  So, sign up, max out, and invest your gains elsewhere!  Happy investing!