Gold ETFs vs. SGBs - Who is the 'Golden Boy'?
An unbiased comparison between Gold Exchange Traded Funds and Sovereign Gold Bonds to help you make a more informed investment decision.
The word that comes up involuntarily when one thinks of investment diversification is indisputably ‘Gold’. India’s culture is deeply woven with this bullion metal. With passage of time and maturity of Indian financial markets better instruments have emerged leaving behind age old way of holding ‘physical gold in lockers’.
The two new-age & significantly efficient methods of investing in gold is Gold Exchange Traded Fund (Gold ETFs) & Sovereign Gold Bonds (SGBs).
But which would suit you best? This article attempts to lend a helping hand.
What are these instruments even?
Gold ETFs, like any other ETFs can be purchased and sold in Exchanges like stocks. They are structured to track Gold and hence the name. This is a passive instrument, meaning the fund manager ensures that these Gold ETFs simply track the prices of Gold (in INR). The popular ETFs in India are:
GOLD BeES, SBI GOLD ETF, Aditya Birla Sunlife GOLD ETF, HDFC GOLD ETF etc.
You can follow these links to read details about each of these ETFs. All of them track gold, so what is the difference between these ETFs? Well, liquidity in these ETFs is a big reason which differentiates each other, tracking error being another.
SGB on the other hand is a bond (I am Bond, Gold Bond!) linked to the price of gold. It is issued by RBI on behalf of government of India (thus sovereign). Like bonds, they have a interest rate and a maturity period. If that was too complicated, lets take an example. Say you bought these bonds equivalent to 1 gm of gold when it was trading at INR 5000/gm. You then held it till maturity (say, 5 years). At the time of maturity price of gold was INR 7000/gm. Then each year you get the fixed interest on invested INR 5,000 (also called nominal value) and at maturity you get back INR 7,000, thus making a profit of INR 2,000 over the period of investment. Simple right! Read this RBI Notification if you want to dive-in further.
Mirror, Mirror on the wall who is the fairest one of all? - Now that you have been introduced to both, it time to find out which suits your investment diversification strategy the best.
Duration of Investment
SBGs have a maturity of 8 years with the option to redeem from 5th year onwards (once every 6 months starting from 5th Year). So you need to have an investment horizon as big as this. You can always choose to sell these bonds in exchanges before that but you will not be able to avail the tax benefit (explained next). Also, these bonds are not very liquid, so selling might not be an easy task.
Gold ETFs can be sold freely at will. There is no restriction or liquidity issues at exit (provided you bought an liquid ETF). If you are a keen market follower and want to time entries and exits into gold you can do so easily using these ETFs. To add, gold moves up sharpest when there is widespread panic for certain reason (think 2008 Financial markets crash, COVID-19 etc.) and falls equally sharply when the situation normalizes. Even if entry wasn’t that great, a timely exit can make all the difference to the returns generated.
Flexibility on investment duration winner - Gold ETFs
Taxation
To sweeten the deal, the capital gains arising out of holding these bonds will not be taxed if held till maturity or redeemed after 5th year. So taking the earlier example of buying the bond at INR 5000 and redeeming it at INR 7000 means, you don’t need to pay any tax on the profit of INR 2000. (Remember to avail this benefit you must apply to the tranche when it opens for subscription. Buying from secondary market does not make you qualify for this benefit.)
Gold ETFs has no such benefits.
Taxation advantage winner - SGBs
Interest Income
Bonds give interest, so does SGBs. The rate of interest is fixed at 2.5% per annum on the invested value (or nominal value as it is called). These are paid once every 6 month. If that was not all, tax is not deducted at source on this interest income. It is taxed at hands of investor as per applicable income tax slabs. Just in case you fall in 0% tax bracket, you pay no tax on this interest income as well.
Gold ETFs don’t pay any such interest income.
Additional income winner - SGBs
Instrument Fees
SGBs are not having any fees. On the contrary they are available at discount of INR 50/gm when applying (for retail investors).
Gold ETFs on the other hand are funds and thus have fees that their respective manager charge. These are called expense ratio and varies anything between 0.5%-1% per annum. Don’t forget to check the respective fact sheet of these ETFs.
Low cost winner - SGBs
Restriction on maximum permissible investment
While the minimum investment that can be made through SGBs is 1 gm, the upper limit of an retail individual is 4 kg across different tranches.
ETFs has no such restrictions. One can accumulate as much one want to at different prices.
No investment limit winner - Gold ETFs
On a closing note, personal finance is ‘personal’ and should suit individual's investment temperament, risk and reward expectations. With the pros & cons clearly explained between the 2 most attractive instruments available in India to invest in Gold, we hope you can take a more informed decision.
But, is gold really worthwhile to invest in? Well, that’s for another time!
Disclaimer: This article is for information only, and should not be considered as a recommendation to buy or sell any stocks/ETFs etc. Stocks/ETFs etc. mentioned maybe part Vantage Model Portfolio and Vantage members might have been advised on it.