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The dilemma of deciding between Sovereign Gold Bond (SGB) and Gold Exchange Traded Funds (Gold ETFs)

01 Sep 2022 0 COMMENT
  • SGBs and gold ETFs are two of the highly recommended ways of investing in digital gold
  • Both these forms of digital gold have some pros and cons in terms of liquidity, taxation and cost
  • SGBs, if held till maturity, are tax-free and offer an additional interest rate
  • Gold ETFs attract short- and long-term capital gains tax depending on the holding period
  • Gold ETFs entail expense ratio, trading cost and demat account charges
  • There is no cost attached at the time of buying SGBs and they only entail demat account charges

Precious metals, especially gold, have been the Indians’ favourite possession since time immemorial. Traditionally, there is emotional as well as financial value attached to the yellow metal.

In financial terms, gold is seen as a perfect hedge against inflation and acts as an insurance during adverse situations. The yellow metal has the uncanny ability to appreciate when there is mayhem around.

Though the attraction of physical gold has not waned in India, investments in digital gold is gaining ground. Two of the recommended ways of investing in digital gold are through Sovereign Gold Bonds (SGBs), which are issued by the Reserve Bank of India (RBI) in tranches, and gold exchange-traded funds (gold ETFs) issued by mutual fund houses.

But which form of gold should be part of your portfolio? Here’s a cost-benefit analysis of which works better for you—SGBs or gold ETFs.

Sovereign Gold Bonds

SGBs are central government-backed bonds, which are denominated in grams of gold and also bear an interest of 2.5 per cent per annum on the issue price. This is an alternative to holding physical gold, and its value is linked to the underlying value of gold as on the day of buying.

They are issued for a fixed term of eight years with redemption options starting from the fifth year, depending on when RBI provides a buyback window.SGBs are suitable for you if you are a long-term investor who wishes to take an investment position in gold while earning a fixed interest rate. If you have invested in SGBs, then you should ideally hold them till maturity as the redemption proceeds are tax-free as per Section 47 (viic) of the Income-tax Act, 1961.

The other advantage of investing in SGB is its structure. It is secure and will give you a sense of comfort as SGBs are backed by the sovereign. Thus, you won’t need to worry about its purity and inventory.

Taxation: From the income tax perspective, interest received on such bonds will be taxable under the head income from other sources. In the event that the bonds are redeemed on maturity, then the same is exempt from tax. However, if the bonds are sold after a period of five years, then gains arising on such transfer will be taxed as long-term capital gains (LTCG) at 20 per cent. The benefit of indexed cost of acquisition will be available to the seller of such SGBs.

Cost: You will not need to pay any charges at the time of buying. However, there may be a cost attached depending on the mode of holding. You can either hold SGBs in your demat account or through an e-certificate mode (non-demat). If you hold them in a demat account, you need to pay the demat account charge. Remember that this charge is not specific to holding the SGBs. It is your regular demat charge which you pay for your demat account.

Gold ETFs

Mutual funds (MFs) offer a convenient and secure platform to invest in this inflation-proof asset class. There are three ways you can invest in gold through the MF route: gold ETFs, gold funds and gold ETF feeder funds. We will discuss gold ETFs here.

With a gold ETF, you can participate in the gold bullion market without taking physical delivery of gold and buy and sell your holdings through stock exchanges. You can trade in them just the way you do in stocks through a registered broker and using a demat account.

Gold ETFs are passively managed funds whose returns closely track those of physical gold in the spot market. You can buy and redeem the units from either the fund house or directly through the stock exchange. You can even invest smaller amounts through gold ETFs and accumulate gold at different price levels.

India’s first gold ETF was launched in 2007 by Benchmark Mutual Fund, which is now known as Nippon Mutual Fund.

Taxation: Gold ETFs attract short-term capital gain (STCG) tax as per your income tax bracket if they are sold before 36 months of buying. If they are sold after 36 months, then LTCG tax of 20 per cent will be applicable and you will also get indexation benefits. Indexation is a type of benefit that lets an investor adjust their original purchase price of an investment with respect to inflation. The Cost Inflation Index (CII), which is announced by the Central Board of Direct Taxes (CBDT) every year, is used to calculate this.

Cost: Although no exit or entry load is charged in gold ETFs, they incur some charges. A gold ETF incurs three main charges and one hidden cost. Those are expense ratio which is taken for managing the ETF, trading cost which is the brokerage fee, and holding cost which is the demat account annual maintenance charge, as applicable.

The bottom line

Both SGBs and gold ETFs come with their own merits and demerits in terms of cost, liquidity and taxation. Conventional investment wisdom suggests that you should go with the instruments that provides higher liquidity. If liquidity is your major concern you may go for gold ETFs. If liquidity is not your major concern and you want tax-efficient returns, hold SGBs till maturity. Remember that SGBs are also traded on exchanges but mostly at a discounted price.

In any case, ensure that gold is limited to 5-10 per cent of your overall investment portfolio.

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