I am a 40 year old wholesaler who traditionally invests in gold in the form of gold coins and biscuits. I recently came across new age instruments for investing in gold such as Gold ETFs and SGBs. Can you please explain the main differences between the two instruments and specifically highlight the risk associated with both.
Naveen Mohanty, Bhuvneshwar
Gold is the trusted choice of investors across geographies and demographics. There are several reasons behind its popularity, including (a) low risk, (b) use in jewelry making, (c) easy access, (d) simple purchasing process. However, some disadvantages are associated with physical gold Also:
Security: Storing large quantities of physical gold in your home can pose a security issue for you and your family.
Liquidity: Physical gold cannot be liquidated in the short term, the process usually involves finding a suitable jeweler or lender and then visiting their office in order to obtain cash. The process may take up to 1 week.
Gold ETF and SGB were introduced to solve all the problems associated with physical gold while retaining all the positive characteristics of physical gold.
Gold ETFs are a subcategory of mutual funds that invest exclusively in gold. The mutual fund company must hold gold, against which it issues mutual fund shares to investors. As a result, your problem related to storing gold is eliminated in the case of gold ETFs. Each share of a Gold ETF represents a certain quantity of gold. At the time of launch of a Gold ETF (called – a new fund offering), Gold ETF units are generally priced at ₹10 and represent a few milligrams of gold.
The aforementioned pricing structure allows investors to invest even minute amounts in gold through these units. The price of these units after issue changes upwards or downwards depending on the market price of gold. Essentially, your investment is tied to the performance of gold as a commodity.
Sovereign Gold Bonds
THE SGB diet was launched by the Reserve Bank of India (RBI) to reduce India’s import bill. India is one of the largest importers of gold in the world, and this import results in a loss of foreign exchange. Although many Indians buy gold as an ornament or jewelry, many Indians also buy gold as an investment product.
SGBs are government securities representing a certain amount of gold in grams. They serve as alternatives to holding real gold. When you buy SGB, the value of your investment is linked to the performance of gold as a commodity.
Although the SGB and Gold ETFs appear similar, there are a few key differences between the two. We have listed the difference below:
In the case of gold ETFs, the investor does not earn any interest; their potential gain or loss depends entirely on the price of gold. However, in the case of SGB, the investor earns an assured interest of 2.5% of the initial amount invested in the SGB scheme.
In the case of Gold ETFs, you can exchange your Gold ETF units for physical gold. Please note, however, that there is a minimum threshold prescribed by the collective investment scheme below which it will not exchange your units for physical gold. Generally, mutual fund companies prescribe units equivalent to 1 kilogram of gold. In the case of SGBs, there is no possibility of converting SGBs into physical gold.
Gold ETFs are classified as debt mutual funds and are taxed accordingly. If you hold your Gold ETFs for a period of 3 years or more before selling them, you will have to pay long-term capital gains tax at a rate of 20%, as well as indexation benefits. In the event that you hold them for a period of less than 3 years, the capital gains that you generate will be added to your income and will then be taxed according to your income tax bracket.
In case of SGBs, you benefit in two ways (a) from capital appreciation – when the price of gold increases and (b) from interest income at the rate of 2.5% per annum. In both cases, your gains/income from SGBs will be completely tax-free.
In the case of SGBs, the duration of the program is 8 years, however, early encashment is permitted from the 5th year. Please note that if you hold your SGBs in demat form, you can sell them at any time on the stock exchange. Gold ETFs can only be held in demat form, they can be sold at any time.
In the case of Gold ETFs, you will first need a demat and trading account to buy the Gold ETF units. In case of SGB, you are not necessarily required to maintain them in demat form. You can also hold SGBs in certificate form.
If you are looking to buy gold purely for investment purposes, SGBs and Gold ETFs are two new-age instruments for investing in gold. Investing in either will solve the traditional problems associated with storing physical gold: security and liquidity.
However, if you are planning to invest in gold with the aim of converting it into jewelry at a later date for your children’s marriageinvesting in physical gold makes more sense.
Kuvera is a free platform for direct investing in mutual funds.
Note: This story is for informational purposes. Please speak to a financial advisor to get detailed solutions to your questions.
Sovereign Gold Bonds (SGB) are government securities denominated in gold with one gram as the base unit.