Comparison between Sovereign Gold Bonds and Gold ETFs:
The Union government has recently introduced a sovereign gold bond scheme, largely to reduce the country’s dependency on imports and channeling unproductive household gold to productive use. Unlike exchange traded funds (ETFs), these bonds won’t be backed by gold, but a sovereign guarantee. Indian entities like individuals, trusts, educational and charitable institutions and HUFs can invest in the sovereign gold bonds.
Having gold in your portfolio will help in diversifying risks, particularly if you have a long-term investment horizon. But at the same time, you should not allocate more than 5-10% of your total portfolio in gold. And if an investment is what you are interested in, owning gold in paper form will serve your purpose in the most cost effective way.
Gold ETFs, on the other hand, have existed in the Indian financial system for several years now. These are simple investment tools that combine the simplicity of gold investments and the flexibility of a stock market. They can be bought and sold like any other stock.
But the availability of both gold ETFs and sovereign gold bonds has left the investor community confused as to which one will meet their purpose. Towards that end, let’s first see how the two investments stack up against each other.
ETFs have always been a good option to invest in gold, but only over the online platform. They are up for grabs anytime during regular trading hours, unlike sovereign gold bonds, for which, the government will intermittently keep the trading window open at post offices and banks.
Gold ETFs have better liquidity than the sovereign gold bonds. The former can be bought and sold on stock exchanges, just like any other scrip. The holding period depends entirely upon the buyer. But sovereign gold bonds come with an eight-year lock-in period. The investor will get the option to carry over his/her holding for an additional period. Investors can also prematurely withdraw from the fifth year on interest payment dates.
Gold ETFs score over sovereign bonds in transparency. Gold ETFs are usually bought at a price which is closest to the actual market price. Here, the price of physical gold is considered as the benchmark. But in the case of sovereign bonds, the price is set by the government.
While gold ETFs have no entry or exit charges per session, there are usually three associated costs. First is the expense ratio involved in managing the fund. It’s around one percent and comparatively lower than the other mutual funds. Second comes the broker cost, which you have to pay while buying or selling ETF. Third, which is actually not a cost but nonetheless impacts return, are the tracking errors. These arise due to the ETF’s cash holdings and expenses that do not mirror the actual price. Sovereign gold bonds, however, have no such costs. There’s only a one percent commission on the invested amount, which the government pays to the distributors, for selling the bonds.
In case of ETFs, there are no earnings on investment, other than the capital gains that arise when the investors sell their holdings. But for the sovereign bonds, the government has fixed the rate of interest at 2.75% per annum, which is paid half-yearly on the invested amount.
One can even buy as little as 1/10th of a gram in a gold ETF. Minimum investment in sovereign gold bonds, however, has to be two grams. The maximum is capped at 500 grams for an individual/fiscal. If it’s a joint holding, then the limit is applicable only for the first applicant.
Interest earned from all bonds is fully taxable according to the investor’s tax slab. For a person in the 10, 20, or 30% slab, the post-tax returns on sovereign gold bonds will be 2.47, 2.18 and 1.9% respectively. After maturity, the difference between the buying and selling price could lead to capital gains and will be treated as equivalent to physical gold. If gold is transferred after a holding period of three years or more, it’s subject to 10% tax or 20% after indexation. Short-term gains below three years are added to the income. Hence, in case of the sovereign bonds, capital gains tax treatment would be identical to gold ETFs or physical gold.
So where to put your eggs?
Both gold ETFs and sovereign gold bonds are paper gold. They are cost effective to hold. The risk of physical stocking also doesn’t arise. ETFs gives an opportunity to investors, to accumulate the yellow metal over a period. Liquidity is also an issue with sovereign bonds as the government controls their trading time. However, bonds score over ETFs by earning interest. So, anyone looking to invest a lump sum for a long-term investment should ideally invest in bonds, while ETFs can be used more as an SIP vehicle.