As gold prices have been falling daily for over a month and property prices are rising under the impact of inflation, many people are looking to park their funds in Sovereign Gold Bonds (SGB) called paper substitutes for holding physical gold.
Unlike the difficulties of storing and securing gold coins or bars in lockers and safes, you can keep the SGB document anywhere in your home. Since the SGB document is in digital format, you can always request a copy of the document from the nearest bank by submitting your PAN card or Aadhaar number, if you lose it.
Many investors are unsure about the effectiveness of SGBs and want to know if they lose value over time. In addition, many people want to know if there are risks of losing the principal of a bond backed by a sovereign guarantee. Questions like these and more are taking precedence over other investment options as gold continues to lose its luster and luster due to its deteriorating market value.
To understand the risks posed by investors regarding SGBs issued by the Reserve Bank of India (RBI), we must first understand what “sovereign guarantee” means and its implications for investors.
First, SGBs are not like other government-issued bonds. They are different in that the central government guarantees investors a fixed rate of 2.50 percent each year, payable semi-annually on the face value.
Investors would benefit from this amount of interest until the bond redemption date. The redemption value would be equal to the average of gold prices during the three days preceding the redemption. The amount of interest is an incentive to encourage investors to invest more in these bonds. This is different from guaranteed interest on other bonds issued by the Indian government.
Government bonds are different. Consider, for example, purchasing a bond that would mature after 10 years. The government agrees to pay you the interest on the bond twice a year until the maturity date. The government will reimburse you for the price of the bonds after the end of the term or when you repurchase the bonds before maturity. The government would rarely fail to pay you the interest amount or repay the bond amount on maturity.
If everything looks so good from the outside, does that mean there is no risk in investing in SMEs? It is true that there may be a risk of capital loss if the price of gold falls.
Rahul Agarwal, owner, Advent financier states: “The redemption amount in an SGB is linked to the price of physical gold and therefore if the price of gold at the time of maturity is lower than the allotment price, investors are exposed to risk in capital. Additionally, given that these bonds have a long duration of 8 years, investors could also be exposed to liquidity risks due to lack of trading volumes.
However, investors have not witnessed or suffered any capital loss on their gold investments. Compared to this, fluctuations in long-term golden or RBI bonds are common. This is especially true for long-term bonds which are more prone to fluctuations.
Muthukrishnan, a Chennai-based company Certified Financial Planner says: “Bond prices and interest rates are linked. When interest rates rise, bond prices fall. When interest rates fall, bond prices rise. Long-term bonds have a longer duration than short-term bonds. Shorter-term bonds are closer to maturity and have only a few coupon payments remaining. They are therefore less volatile. Long-term bonds are further out and still have many coupon payments remaining. This is why they are more volatile.
Prathiba Girish, Founder, Finwise Personal Finance Solutions says: “Long-term bonds have a longer duration. Bond prices are inversely related to interest rates. In a rising rate scenario, the price of bonds decreases with each increase in the interest rate and vice versa. This is because the price of a bond is the present value of all future cash flows. In short-term bonds, since the time frames are limited, the current value is not much different and are therefore less volatile.
If you sell your government bonds or SGB before maturity, there is always a risk of capital loss in both cases.
Rely on the evolution of the price of gold
Many investors believe that gold prices always rise in the long term. Their understanding of gold investments is supported by data suggesting that gold has generated a return of over 54,000 percent to its investors since the country’s independence.
Even though the metal’s prices tend to fall temporarily, their rise over the period, coupled with the biannual interest, gave them enough reason to put their money there. Unlike stocks that crashed and lost their value for a short, sporadic post-pandemic period stock market crashesgold prices have continued to rise.
A good example of this is how gold prices continued their upward trend after the 2008 global crisis. economic downturn. Apart from stocks, bond investments have also come under scrutiny as the government may fail to deliver on its promise.
Should you buy SGBs?
Please note that SGBs are not the same as gold mutual funds which you can redeem in a year. Buy SGB only when you are ready to invest in it for the entire period. Gold is considered a perfect hedge against inflation; However, it may not be ideal if you are buying it to diversify your portfolio.
This is because you cannot buy or sell SGB at your convenience. If you want to adopt a tactical strategy, invest in gold funds or Gold ETFss is better. Buy SGB only if you are willing to buy and hold. This is when SGBs are completely risk-free.
Here we explain the issue prices of sovereign gold bonds since 2015