Since the start of the year, Gold has lived up to its expectation of being a safe haven. The financial and non-financial world thrown in turmoil due to the pandemic plus its geopolitical aftermath and the volatility of stock markets has led to gold delivering superior returns in this year.
So, it won’t be wrong to say that the risk aversion of investors has ensured that gold prices are continuously being pushed upwards.
A good recent run-up can attract many to reconsider gold as a long-term investment option. Flowers do attract the bees. Don’t they? 🙂
But investors need to understand something about gold and its behaviour.
Gold is unlike stocks and bonds. Gold has no intrinsic value or cashflows to offer. So the concept of valuation isn’t exactly applicable here. And the gold prices are more about the demand-supply equation at any point in time and factors affecting this equation (like financial crisis, geo-political issues, etc.).
As a result, the price of gold has a typical pattern. And this pattern is occasionally accompanied by high volatility. Gold has got a bad name for giving lumpy returns. That is, it does nothing for years but suddenly out of the blue, it great returns occasionally that pushes up the long-term’ averages (read an interesting take on averages here).
So, for a lack of a better word, and like equity investing, even gold has a timing angle to it. So, if you want to time gold investments, do note that it’s about accumulating it in years (or period) in which it hasn’t been giving great returns.
But let’s not discuss the timing of gold investments for now. Let’s first see which are the best ways to invest in gold for the long-term portfolio and then, we discuss about how much gold to hold for long-term investments.
Options Available for Investing in Gold in India
The primary ones that are available are physical gold, gold ETFs, Gold Funds, and SGB (Sovereign Gold Bonds).
We Indians are known for this but the fact is, that buying physical gold has its own share of problems like quality, storage and safety issues, lack of liquidity, making charges, etc. So, it’s out of the question from a practical perspective.
Let’s look at other options.
Gold ETFs in India (2020)
Gold ETF is a type of exchange-traded fund with physical gold that has a 99.5% purity as the underlying asset. These Gold ETFs are listed on exchanges (NSE, BSE, etc.) where they can be bought or sold like normal stocks.
The major benefit of investing via Gold ETFs is its ease and transparency with which you can invest in Gold. And you get to take exposure to this precious metal in a cost-effective manner, at prices that are more or less similar to the on-going prices of gold for the day in real-time.
Since Gold ETFs can be traded only on stock exchanges, you need to have a demat account in order to buy or sell Gold ETFs. This means that there is an additional cost of demat and brokerage charges on the execution of the buy/sell transaction. In addition, ETFs also have expenses associated with them that can be 0.3-0.8% per year.
Many people look for the best gold ETFs in India. But remember that gold ETF just tracks the gold price. So apart from the small tracking error, most gold ETFs will provide similar returns. Of course, different ETFs will have different liquidities and that is something that investors should make a note of.
Here is the list of different Gold ETFs available in India:
- Axis Gold ETF (AXISGOLD)
- Birla Sun Life Gold ETF (BSLGOLDETF)
- Canara Robeco Gold ETF (CANGOLD)
- HDFC Gold Exchange Traded Fund (HDFCMFGETF)
- ICICI Prudential Gold Exchange Traded Fund (IPGETF)
- IDBI Gold ETF (IDBIGOLD)
- Kotak Gold Exchange Traded Fund (KOTAKGOLD)
- Quantum Gold Fund (QGOLDHALF)
- Reliance Gold Exchange Traded Fund (RELGOLD)
- Religare Gold Exchange Traded Fund (RELIGAREGO)
- SBI Gold Exchange Traded Scheme (SBIGETS)
- UTI GOLD Exchange Traded Fund (GOLDSHARE)
And if you are planning to invest in gold ETFs, you would be better off sticking to the ETFs that have high trading volumes (i.e. better liquidity) and as a result, less price distortion relative to the NAV of the ETF.
Sovereign Gold Bonds in India (2020)
I have written about the features of SGBs in India. You can read it to understand the details. But for a reminder, here is a refresher below:
The Sovereign Gold Bonds (or SGBs or popularly called Gold bonds) are bond securities denominated in weight, i.e. grams (gms) of gold. These are backed by the government of India and were launched a few years back to act as substitutes of physical gold and deter Indians from buying physical gold.
These are issued by the Reserve Bank of Indian (RBI) on behalf of the Indian government (to know more, check additional details via RBI’s site link).
SGBs are issued through limited period offers that are open about 5-6 times a year (read more about the Sovereign Gold Bond schedule in India). At the time of opening of subscription, the investors have to pay the issue price of the series. The golds bonds are issued several times a year by the RBI in different tranches that are priced at different levels – based on the simple average closing price (published by the India Bullion and Jewellers Association Ltd or IBJA) for gold of 999 purity of the last three working days of the week preceding the subscription period. To know more about the historical issue prices of these bonds since the start of SGB gold bonds in 2015, please refer to the detailed post titled Gold Bond Issue Price History (Since 2015).
The tenure of the Sovereign Gold Bonds is 8 years from the date of issue. But for those who do not want to stay put for 8 long years, there is an option for an early exit. One can exercise this option after 5 years. So, if an SGB subscriber wants, they can redeem their investments in the years from 5 to 8 though no redemptions will be allowed before completion of the 5th year.
And what to do if one wants to exit even before the 5th year?
These gold bonds become tradeable on stock exchanges within 14-15 days of issuance. So the SGBs can be sold in the secondary market before the 5th year. But make a note of the point that when you sell bonds on an exchange, the market price of the bond today or gold bond rate today may be lower or higher than its original price on which it was issued to you initially.
To check how each of the previously announced SGB Series is trading, check this link on NSE’s site.
Now comes the best part about SGBs.
The SGBs are designed to track the price of gold. So the returns you can expect from these should be similar to returns from gold prices.
But SGBs offer something else too. Something additional.
An additional 2.5% per annum of fixed interest. This interest is paid semi-annually on the original investment value and not the current market value of gold. So, let’s say you bought gold bonds at the rate of Rs 3800. Now the prices have risen to Rs 4700. Then the additional 2.5% interest will be paid to you on Rs 3800 which is the initial investment amount and not the current value of Rs 4700.
So what is the difference between SGB Vs Gold ETFs?
- Since SGBs track gold prices and offer an additional 2.5% interest, SGBs score over Gold ETFs which don’t have the additional interest component. In gold ETFs, it’s simply about your return is equal to the appreciation in gold prices during the holding period.
- Gold ETFs are more liquid than SGBs. If you check the exchange date (link), you will see that most gold ETFs in India get traded sufficiently that small investors of gold ETF will not face much liquidity risk. On the other hand, if you check SGB trading data, the volumes are very low currently. So in liquidity, gold ETFs do better.
Now you may ask that which amongst the two, i.e. Sovereign gold bonds or ETFs is better for gold investment?
- If you are planning to use gold as a tactical part of your portfolio which you will regularly buy and sell, then you need to value liquidity more. And hence, investing in gold ETF is more convenient.
- If you plan to hold a large corpus in gold for the short term, then having it in SGB will mean that you will need large volumes on exchanges to exit your positions. But that is not feasible currently due to poor volumes of various SGB series of stock exchanges.
- But if you are investing in the long term and are sure that you won’t need to exit before 8 years or so, then SGB may be a better option.
- Or a combination of SGBs and ETFs can be taken to gradually build up allocation to gold in your long term portfolio. This will provide a good balance of liquidity (via ETFs) and higher returns (via SGBs).
There is another option for investing in gold. These are Gold Funds.
Gold Funds in India (2020)
These are simply mutual funds that invest in gold ETFs. So it’s a way of taking exposure to gold ETFs without buying the directly or via demat account. But it carries an extra layer of costs towards management fees that reduces returns a bit when compared to gold ETFs.
In the US, there is a specialized type of individual retirement account (IRA) called the Gold IRA, also known as a Precious Metals IRA. Managed by the Gold IRA companies, these accounts allow investors to hold physical gold or other approved precious metals as qualified retirement investments.
Let’s also look at the taxation part of these gold investments.
Taxation of Gold ETFs and SGBs
Here is how Gold ETFs and Gold Funds are taxed:
- If you generate short-term capital gains on the sale of gold ETFs and Gold funds, i.e. gains generated in less than 36 months, then these gains are taxed at the income tax slab rates applicable to you.
- If you generate long-term capital gains on the sale of gold ETFs and Gold funds, i.e. gains generated in more than 36 months or 3 years, then these gains are taxed at 20% (plus any cess) with indexation benefits (i.e. indexation allows you to adjust the purchase price of gold for inflation based on the latest CII index numbers).
The Sovereign Gold Bonds 2020-21 have different aspects to their taxation.
- The 2.5% interest income that is generated by Gold Bonds is taxable. At what rate? The interest income is added to the total income and taxed as per an individual’s income tax slabs.
- The capital gains generated when you redeem SGBs between 5 and 8 years are tax-free, i.e. exempted from taxes. So, you don’t need to pay any capital gain tax if you hold your Sovereign Gold Bonds till their full maturity.
- Even before their maturity after 8 years, the gold bonds can be bought/sold on the exchanges just like normal equity stocks. So, gains/losses from the sale will be considered as a capital gain (or loss). But here again, your holding period shall be considered for deciding the type of capital gains. So, if you sell within 36 months (or 3 years), then it’s considered as short-term capital gains. But if sold after 36 months, then it is considered as long-term capital gains. And you already know that the short-term gains are taxed as per the income tax slab and the long-term gains are taxed at 20% with adjustment for indexation.
To know more about the taxation aspect, read Taxation of Gold in India.
How much Gold to hold in long term Portfolio?
There is no one right answer here, to be honest. But in general, having some exposure to gold (ranging from 5-15%) in long term portfolio is advisable.
It’s worth mentioning that gold is more of a diversifier in your portfolio and a kind of hedge. It generally shouldn’t be the core of the portfolio unless you know what you are getting into. Remember, gold returns are very lumpy. They don’t move much for years and then suddenly shoot up. So, increase the exposure when returns have been bad for some time and accumulate. And when it shoots up and you have ridden the wave a bit, it’s best to reduce exposure. I know all this sounds like timing but that is how it is.
I would suggest not trying to buy a lot of gold (via SGB and/or ETFs) in one go. It’s best to spread your investments in gold. And since both gold SGBs and gold ETFs have their advantages and disadvantages, it makes sense to gradually use both for your long-term investments. That is, investors can hold a combination of SGBs and gold ETFs. How? You can use purchase SGBs occasionally when new series are announced and you have funds available to invest. This can be augmented by purchasing gold ETFs when there are temporary short-term corrections in gold prices. Or if you want to accumulate gold regularly, then do a SIP in Gold ETFs every month. Plain and simple.