You’re busy with new clothes, gadgets, and crackers galore this festive season. It’s also that auspicious time for you to add to your gold hoarding. But if your intention is ‘investing’ in gold, are you doing it through financial gold or physical gold? What’s the difference?
Physical gold is gold that is tangible and which you can physically hold. That’s your gold jewellery, coins, bars and the like. Financial gold is a financial instrument that derives its value from gold and has gold as the underlying investment. There are several types of financial gold products; the convenient ones among these for the purpose of investment are below.
What they are: An ETF (or an Exchange Traded Fund) is an instrument that represents an index or a commodity – in this case, that commodity is gold. To create an ETF, the institution setting it up (usually, they are asset management companies) pools together large sums of money from institutional investors. It uses this money to buy the equivalent in gold bars. It holds this gold in its physical form at warehouses. It then draws up creation units to represent this gold. These creation units are listed on the stock exchange at the prevailing gold price. When you buy these units, you will be effectively investing in gold and when you sell your units, you’re selling your gold. As the gold prices move, the ETF prices moves in tandem. Thus, you get the benefit of buying and selling gold at market prices.
Investment method: You can buy ETFs only on the stock exchanges. Therefore, to invest in gold ETFs, you require a demat and trading account.
What they are: Gold funds are mutual funds that invest in gold ETFs. A gold fund pools in money from investors like you and me, and invests this in gold ETFs. What you buy and redeem are units of the gold mutual fund. Usually, the AMC running the gold fund will invest in the ETF that it is running. For example, SBI Gold Fund will invest in SBI Gold ETF. Gold funds usually have slightly higher expenses than gold ETFs, because they have to account for the costs in continuous deployment of funds and continuous redemption requests. That is, the fund will always have investors putting in and withdrawing their money, which have associated costs. Even so, expense ratios for gold funds are very low at 1% or below.
Investment method: You can invest in a gold fund just as you would with any other mutual fund. You don’t need a demat account; you just need to be KYC-compliant.
Sovereign gold bonds
What they are: The newest form of financial gold, sovereign gold bonds are issued by the Reserve Bank on behalf of the government. These issues are done in batches. The bonds have an 8-year maturity. Each bond represents one gram of gold, and you can buy up to 500 grams in a financial year. Both the purchase price and the redemption price of the bond is the average of the closing gold prices in the preceding five days. In the newest tranche that is opening today (i.e. Oct 24), you will get a discount of Rs 50 on the average price at the time of purchase. Know that the Reserve Bank isn’t going to buy any gold bars or coins or jewellery with your money – its simply giving you a bond whose price is determined by gold prices. Because the bonds have a sovereign guarantee, you run no risks other than the price of gold. The added bonus in sovereign gold bonds is that they pay interest (on the original value of your investment). Up until the latest tranche, this rate was 2.75% per annum. The new issue’s interest rate is 2.5%. This interest, of course, is taxed at your slab rate. You can transfer the bonds before maturity if you so wish. If you hold the bonds in demat form, you can sell it on the exchange. Else, you can exit the bonds on the interest payment dates by communicating your intention before this time (after the fifth year).
Investment method: You can invest in these bonds through your bank, designated post offices, or your broker. You can either hold these bonds in paper form, i.e., you will have a Holding Certificate as proof of your investment, or you can hold them in demat form.
Except for sovereign gold bonds, the tax rule for gold in any form – coins, jewellery, bars, ETFs, funds – is the same. Gains on sale attract capital gains tax of 20% with indexation on holding periods of more than 3 years. For holding period less than this, capital gains are taxed at your slab rate.
For gold sovereign bonds, capital gains are tax-free provided you hold the bonds to maturity. If you transfer it before this time, the gains are taxed just like other gold investments.
Financial gold is more suitable for investment purposes than physical gold. One, they are cheaper – no making charges and no wastage! – and you have better price discovery as a result. Two, you don’t have to stress over their storage or possible theft. Three, they are easy to sell and buy. Of course, there is the added relief that you won’t be duped on the purity front!