The Investor's Guide to Silver ETFs

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There are several good reasons to consider adding silver to your portfolio including:

  • Silver's low correlation to other asset reduces risk in a long-term portfolio. 
  • Silver acts as a store of wealth during times of high inflation and serves as a hedge against declines in the U.S. dollar.
  • Unlike gold, silver has many more industrial uses. 

Fortunately for investors the advent of silver exchange traded funds, or ETFs, has made it easy to get exposure to the commodity without the hassle of physical delivery, storage, and insurance.

But not all silver ETFs are created equally. Investors need to understand how differences in these funds are structured can drastically affect returns. 

Silver ETFs can be broken down into three categories: bullion, futures, and ETNs. 

Bullion funds

Bullion funds hold silver directly in a vault.

Because the value of the fund is determined solely by the price of silver, bullion funds are the most accurate at replicating the price of the underlying commodity. However, because of how these funds are structured, they're considered collectibles and gains are taxed at a maximum rate of 28%. 

Today, there are three bullion ETFs available:

iShares Silver Trust (NYSEMKT: SLV): This fund is the most popular of all silver ETFs with $7.1 billion in assets under management. Because of the funds enormous size, SLV is the most liquid with the smallest bid-ask spread. This makes the fund an ideal candidate for short-term trading. 

ETFS Silver Trust (NYSEMKT: SIVR): This fund provide the same exposure to physical silver as SLV but costs 20 basis points less in annual management fees. For investors with a long-term time horizon this fund is an ideal choice.

The downside - this fund isn't nearly as popular as SLV with only $360 million in assets. Thin trading means this fund has a wider bid-ask spread making it less suitable for frequent trading. 

Sprott Physical Buillion Trusts (NYSEMKT: PSLV): Sprott is the newest edition to the silver ETF family. This fund has three key benefits 1) Silver bullion is stored in Canada providing with a degree of geographical diversification 2) Investors with sufficient holdings can redeem their silver bullion and 3) Some investors can qualify for a lower tax rate.

Clearly, the benefits of this fund are attractive to some members in the investment community. Since being released in 2010, the fund has quickly acquired over $1 billion in assets. 

Futures funds

Futures funds are a little different. Rather than hold physical silver bullion in a vault, these funds hold futures. Futures are financial contracts that obligate the buyer to purchase an asset, in this case silver, at a predetermined time and price. Futures funds track the price of silver closely, but may deviate due to nuances of the futures market like contango or backwardation.

The benefit of futures ETFs is that they're taxed at a blended rate between short-term and long-term capital gains. This blended rate is typically lower than physical bullion products. 

DB Silver Fund (NYSEMKT: DBS): This fund holds front month silver futures contracts . Returns are driven by changes in the price of silver, interest earned on uninvested cash, and roll yield

Exchange Traded Notes

Exchange Traded Notes, or ETNs, represent unsecured debt from the issuer. But rather than paying a fixed rate of interest, returns are determined by changes in the value of an index.

The benefit of this fund structure - profits are taxed at a lower rate because they're treated as capital gains rather than collectibles. The draw back - ETNs expose investors to the credit risk of the underlying issuer. 

UBS E-TRACS CMCI Silver ETN (NYSEMKT: USV): UBS is the only company to offer a silver ETN. But investors should be warned. This fund has less than $25 million in assets making it extremely illiquid. 

Foolish bottom line

So historically, which type of fund has performed the best?

Let's consider an investment period between January 31, 2010 and January 31, 2013. During that time, spot silver prices increased 92%. 

At first glance it appears the iShares Silver Trust is the best investment choice. During that time period, the fund most closely matched the underlying commodity returning 91% for investors. 

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Of course Uncle Sam wants his cut. After factoring in taxes, the UBS E-TRACS CMCI Silver ETN actually outperformed its peers returning 72% for investors in the top tax bracket. 

Robert Baillieul has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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