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Pros And Cons Of Investing in Sovereign Gold Bond

20 Dec 2022 0 COMMENT

Introduction

Sovereign gold bond benefits are numerous. It is simple, it is non-physical and it offers interest over and above gold price appreciation. One of the biggest benefits of sovereign gold bonds is that it offer a good hedge to your overall portfolio during tough times. However, it is not just about gold bond benefits since there are some down side risks too.

We must not only look at the benefits of sovereign gold bond but must also look at the pros and cons of investing in SGB. The long lock-in period, the limited secondary market liquidity, gold price risk etc are some of the downside risks in gold bonds. Here we look in detail at the sovereign gold bond pros and cons.

Why invest in SGB

Investing in gold through SGBs is simpler and quicker. On top of that the principal in gold units and the regular payment of interest are guaranteed by the government, so there is no risk of default. Also, gold reduces the risk of equity and bonds portfolio in uncertain times, since gold normally performs the best when there is uncertainty.

Benefits of SGB

There are several benefits to investing in SGBs. For example, it is a play on the price of gold, without the hassles of physical ownership. So no worries about depletion, storage  and custody of gold. Gold bonds can be held in demat form or as certificates issued by the RBI and both are a lot simpler than holding physical gold. Above all, if you are a long term investor, then holding sovereign gold bonds for the full tenure of 8 years gives you tax free capital gains. Overall, SGBs score on safety, simplicity and asset diversification.

Pros and Cons of investing in SGB

Let us start with the upsides of investing in gold bonds. Here are some upsides of SGB investing.

  • The investment process  is simple and it can be down offline or online through your banking or your trading account. Also, the KYC is minimal and only a basic PAN based KYC is required.
  • The interest and the principal in units of gold is guaranteed by the government, doing away with any default risk on this investment.
  • By holding the bonds for the full tenure of 8 years, the capital gains is entirely tax free, and that substantially improves your post-tax yield.
  • There is substantial leeway to invest in gold bonds. Investors can invest a minimum of 1 gram and a maximum of 4 KGs per person. If there are multiple members in your family, up to 4 KGs can be invested in each person’s name.
  • The SGB price appreciates with the price of gold, so it is like owning gold without the hassles of physical holding. It is much cheaper to hold as SGBs than physical gold.
  • SGBs mirror the price of gold like gold ETFs do, but they have the added advantage of paying 2.5% annual interest on the principal amount.

Let us now look at some of the downside risks of SGBs.

  • SGBs carry gold price risk. In the past we have seen that gold prices have been in a long term falling trend. For instance, between 1981 and 1999, gold fell all the way from $980/oz to $240/oz. SGBs would not be profitable in these conditions.
  • SGBs have to be held for 8 years to be free of capital gains tax. Any holding below that makes the capital gain taxable. Also, the interest earned is fully taxable at peak rates.
  • While SGBs are normally listed on the stock exchanges at the end of 6 months of issue, the secondary market trading is very thin. Either, you do not get liquidity or the prices are too skewed.
  • Unlike gold ETFs, which are available at real time gold prices with total liquidity, SGBs are only available in tranches and exit is only possible when the government opens the repurchase window after 5 years.
  • Currently, SGBs only accept investments in cash and redeem in cash. The scheme may be more useful if it also has a gold monetization angle to it.

Conclusion

Despite the several risks in a Sovereign gold bond, these products have emerged as a veritable method of investing in gold with minimal risk and minimal hassles. Above all, it is a great investment to diversify risk of the portfolio.