There is no perfect substitute for holding real, physical gold bullion. However, for some investors, Krugerrands and gold bars just aren’t viable options. After all, a single ounce of gold is now worth over $1,500, and buying in increments of less than one ounce can be costly, as the cost of producing the coin or bar cuts into the amount invested in the actual metal. While silver is often recommended for those who cannot easily shell out $1,500+ on a regular basis, for those who will have no substitute for gold, ETFs. gold-mining stocks, and gold mutual funds are additional possibilities.

ETFs, or exchange-traded funds. buy actual gold for you and other investors. You buy shares of the fund just as you would a stock, and since its sole holding is gold bullion, the idea is that the price of the fund mimics the price of actual gold. However, some investors are skeptical of ETFs, charging that the funds do not really hold the gold they say they do, and that these funds are really just another tool for the manipulation of gold’s market price. Whether or not these charges are true, enough investors believe them to cause a serious disconnect between the funds’ share prices and the actual price of gold.

Gold-mining stocks are another alternative. Here, you can often get a leveraged play on gold, since many gold-mining stocks go up or down much faster than the price of the metal they mine. If you’re really bullish on gold, then buying an un-hedged gold-mining stock can be your best bet, although there are pitfalls to individual stock investing, to be sure. For instance, when buying just one gold-mining stock, you’re not only betting on gold, but on that company’s management, too. If the company makes a costly error in developing an unprofitable mine, for example, then you could see your investment fall in value even as gold rises.

This is why gold mutual funds are so attractive to the investor who either cannot buy physical gold, or who simply wants to take a shot on the leverage that gold-mining stocks can offer. With gold mutual funds, you get a variety of gold-mining stocks all at once, chosen and traded by professional managers—you diversify your holdings within the realm of gold-mining stocks, mitigating the company-specific risk that buying one, individual gold-mining stock brings with it.

Reasons to Buy Gold Mutual Funds

The biggest advantage of gold mutual funds is that, after your initial investment of typically $1,000 or $2,500, you can normally add small investments of $100 or less on a regular basis, at much lower transaction costs. If you were buying an individual stock, then you could count paying $7-15 per buy, and the smaller your buy, the greater this takes away from your eventual returns—not so with mutual funds. Instead, with funds you pay a “load,” which is not a flat fee but a percentage of your investment—and many funds are in fact “no-load” funds.

Another reason to buy gold mutual funds is if you have a 401(k) through your employer—especially if your employer matches a portion or all of your contribution. If you have an Individual Retirement Account (IRA), you should be able to make the account self-directed and thereby buy actual gold bullion to hold in the account. However, if you’re looking for the leverage that mining stocks can offer, or for some reason you can’t or won’t set up your IRA for bullion investing, then gold mutual funds are a great option for you, too.

One knock against gold is that it doesn’t produce interest or dividends—but gold mutual funds do. If you are a goldbug but want an investment that produces income, than gold mutual funds are an excellent option.

Drawbacks of Gold Mutual Funds

There is a flipside to every coin, and many of the advantages of gold mutual funds can also be viewed as disadvantages. First and foremost, gold mutual funds are not physical gold—there is no substitute for holding actual bullion. Secondly, although individual transaction fees are low, the costs paid by the fund when buying and selling stocks is passed on to you, as are fees associated with the management of the fund itself. After all, these professional managers have to be paid—and so do their assistants, secretaries, etc. Luckily, most funds are large enough and have enough investors that these fees are rather minimal when spread across all of the fund’s shareholders.

Finally, you’ll have to be wary of taxes. Physical gold is not taxed, but when shares of stock are sold for a profit, this results in a taxable capital gain. Mutual funds pass on these capital gains to their shareholders who must then report them on their tax returns.

How to Evaluate a Gold Mutual Fund

When choosing a gold mutual fund to buy, there are several things to consider:

1-Year Performance. This shows the growth in an investment in the fund over the past fifty-two weeks. In our examples, the year ends April 21, 2011.

5-Year Performance. This show the total return you’d have if you invested five years ago—it is not the annual return, but the total return for the five-year period. Past performance is no guarantee of future results, but obviously, higher numbers in these first two categories generally mean a better-managed fund.

Yield. This is the dividend payment yield of the fund. If you’re looking for income, the higher the yield, the better.

Minimum Investment. Mutual funds have a minimum initial investment, after which, small, regular investments can normally be added. Minimum investments are normally no lower than $1,000, and can be much, much higher. The minimum investments for the funds examined here range from $1,000 to $10,000, although most are no higher than $2,500.

Load. As stated earlier, a “load” is a percentage-based transaction fee. If the fund’s load is 5.75%, and you invest $1,000 in the fund, then $57.50 will be deducted from your investment as a transaction fee, leaving $942.50 to be invested. This may seem like a high fee, but when you consider the fact that you’re actually buying many stocks at once, which are then actively traded at no direct expense to you, it’s not so bad. Furthermore, if you make small investments in the future, the transaction costs are much smaller, since instead of being a flat $7-15, they’re a percentage of your investment. A $50 investment, for instance, would have a transaction cost of less than $3. However, it should be noted that there are no-load funds, and studies have found there is little to no correlation between fund performance and load size.

Expenses. These are the total expenses of the fund, expressed as a percentage. These expenses include all of the management fees as well as the transaction costs associated with the actual buying and selling of shares within the fund. You might think that low expenses were better, but then again, you get what you pay for, right? Actually, you should trust your first instinct in this case, as studies have found that when expenses are included in performance calculations, low-expense funds outperform high-expense funds, on average. There are always exceptions, of course.

Assets. This refers to the total size of the fund. Is bigger better? Not necessarily. Smaller funds can be more swift and agile in moving in and out of stocks, but bigger funds have greater economies of scale. It is a trade-off, and no one can say which is definitively better, but the size of a fund is something to take into consideration.

Turnover. This statistic shows how much of the fund’s portfolio is “turned over” each year. A high turnover ratio means that the fund changes a lot over time, with active trading by management. A low turnover indicates little trading; a more stable, conservative approach. Which is better? It really is up to the individual investor’s taste, but the statistic is worth noting.

With all this in mind, here are eight gold mutual funds I’ve identified as friendly for individual investors (as opposed to institutions), with reasonably small minimum investment requirements. All of these funds are open to new investors. I’ve rated them based on a formula taking into consideration their one- and five-year returns, their yields, and their loads and expenses.

1. Van Eck Intl Investors Gold A (Ticker: INIVX)

2. Oppenheimer Gold & Special Minerals A (Ticker: OPGSX)

3. Franklin Gold and Precious Metals A (Ticker: FKRCX)

4. Invesco Gold & Precious Metals Investr (Ticker: FGLDX)