Spreads and Other Costs

I've made it a rule for myself to make long term investments rather than opportunistic short term trades. This has several advantages, the main one being that it frees me from having to pay attention to short term moves. I can do other things while I wait for the long term trend to play out. One way to look at this is that time is a valuable resource that shouldn't be wasted. It should be enjoyed. Spending too much time following market action is therefore a cost to be avoided.

Another advantage to my strategy is the fact that spreads and other costs associated with transactions become less important. While the spread is a major cost to a day trader, it's of little importance to those holding onto an asset for years before selling. This allows us to consider a wider range of assets. We can buy real-estate and physical gold rather than their related paper versions.

The cost of buying a house is so high that it only makes sense to buy and hold for years. The same is true for physical gold. A day trader is therefore limited to paper versions of these asset types. They can buy real-estate related companies, they can trade gold futures, and they can trade shares of gold mines. But they cannot lay their hands on the actual underlying good. Only those with a long time horizon can do this.

Being limited to paper assets is a cost to those with a short time horizon, because paper assets can default. Real-estate companies and gold mines can go bankrupt. Future markets may break. Gains seen in physical assets may not translate into corresponding gains in paper counterparts.

This is not to say that spreads are irrelevant to those with a long time horizon. It's a cost worth avoiding as much as possible. The point is that spreads shouldn't prevent us from buying physical assets. The fact that physical gold trades at a premium to paper counterparts is not a reason to avoid it as a long term investment.

Rather than comparing physical gold to its paper equivalent, the right way to view it is to compare it to owning real-estate. If we buy a second home as an investment, we do so with a long time horizon in mind. We do so knowing that there are all sorts of expenses associated with both buying and selling. There are fees and taxes to be paid while we hold it. If we intend to rent it out, there's overhead and costs associated with that too. Furthermore, it cannot be bought or sold in pieces. It's all or nothing.

Compared to real-estate, physical gold has all sorts of advantages. The spread is smaller, storage cost is very low, and there's no demand on us for maintenance. Physical gold is a perfect alternative to real-estate, especially for lazy people like myself. Furthermore, the cost of owning physical gold can be lower than that of owning paper assets. There are no inherent annual fees associated with physical gold. This becomes all the more appealing during times of increasing taxes. Real-estate and paper assets can be taxed. Physical gold, on the other hand, cannot be taxed without our willingness to inform the taxman about our holdings.

Over a long enough time span, physical gold comes out very cheap to hold, so much so that it dwarfs the transaction costs. But this requires planning from our side. We mustn't buy so much gold that we'll be forced to sell within a year or two. Here again, we must view our physical gold as being similar to real-estate. We mustn't buy too much. Our purchases should be such that we get the benefits of ownership without the stress and anguish associated with stretched positions.

Cottage

By Valtov at fi:wikipedia - Originally from fi:wikipedia, Public Domain, Link