Gold ETFs, SGBs or Digital Gold: Who is golden of them all?
An unbiased comparison between Gold Exchange Traded Funds and Sovereign Gold Bonds and why you should avoid Digital Gold!
Recently I came across an App (read about it here) which rounded up your expenses (to the nearest 5 or 10 multiple) and invested that rounded up amount in digital gold. While I wish this App good luck in their venture, Indian investors - both new & old, ought to know what are the best & worst instruments out there, if they want to invest in this well loved asset class - Gold.
Firstly, lets put the case of digital gold to rest. This perhaps is the worst way to invest in gold. Period!
There is ~3% spread on buying & selling to cover for insurance etc. Additionally, there is 3% GST digital gold purchase. So digital gold’s value needs to appreciate by 5-6% just to breakeven. Holding beyond 5 years will incur storage charges which is yearly 0.3-0.4% of the gold value.
This being in addition to Long Term or Short Term Capital gain tax which is similar to that on physical gold. (STCG applies if you sell before 3 years and is taxed as per your income rate tax slab. Over 3 years, you are liable to pay 20% of returns as taxes with addition of any surcharges & 4% cess.)
Also, such investments don’t come under the purview of SEBI or RBI as digital gold are neither collective investment scheme nor a deposit. As a result if any of your transactions don’t go through as expected you will not be able to lean on SEBI’s or RBI’s protection policies. Though these digital gold providers (MMTC-PAMP, SafeGold etc.) do appoint a security trustee themselves.
The need of a regulatory agency becomes even more critical for digital gold.
But Why?
Because you can only sell the digital gold back to the platform you bought it from. Another way of redeeming it is by exchanging your gold for jewelry only through partners empaneled by these digital gold providers. You can also gift it to any recipient of your choice provided it is exercised through a method or functionality offered only by these providers. You may now appreciate better why your digital gold investment depend heavily on business tie ups of such digital providers.
The only more inefficient way to invest would perhaps be physical gold coins or biscuits.
The advantageous bit about digital gold is the greater accessibility to transact via various payment apps (likes of PhonePe, Paytm etc.) which gives user no clue about the kind of cost their investments are going to bear. Other being the ephemeral flexibility of investing as low as INR 1. But does INR 1 even qualify to be called investment whatever the asset be?
With digital gold out of our way, lets focus on two new age and significantly efficient methods of investing in golf - Gold Exchange Traded Funds (Gold ETFs) & Sovereign Gold Bonds (SGBs).
What are even these instruments?
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 somewhat differentiates one from other, tracking error being another. But for the purpose of investment there are going to perform very similar to each other, after all they are linked to the same asset - gold.
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 finally at maturity you get back INR 7,000, thus making a profit of INR 2,000 over the period of investment due to appreciation of gold prices. 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 but you will be able to sell it
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. 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. (This benefit is available even if you purchase SGBs tranche from secondary markets in addition to directly applying for subscription). However, if sold in secondary markets prematurely after 5th year but before maturity long term capital gains tax applies(which is 20% without indexation benefit & 10% with indexation benefits).
Gold ETFs has no such benefits as there is no concept of maturity for it.
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 before zeroing on any of them.
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
Need of a Demat Account
While opening a demat account today is faster than getting your food delivered through delivery apps, if you still don’t want to get into that hassle you don’t need to, if you purchase in SGBs. Such customers will receive physical & electronic copies.
For the case of Gold ETFs you cannot hold them unless you have a demat account.
Need of Demat Account winner - SGBs
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, I hope you would be able to take a more informed decision.
But, is gold really worthwhile to invest in? Well, that’s for another time!
PS: Gold Mutual Fund are another option which invests in gold ETFs, and you don’t need a demat account to hold them.
Hope you found this article thought provoking & interesting. If you missed reading by Sula Vineyards: How ‘high’ are the prospects? by Dalal Street Rafting check it out below.
Disclaimer: Views presented in this article is personal opinion of author and doesn’t not represent any firm’s view that he is currently associated or might have been associated in the past. No part of it should not be considered as a recommendation to buy or sell any stocks etc. This is an educational article at best. Although care has been taken for correctness of the data, author does not take any responsibility for any errors or omissions. Readers should consult their financial advisers before taking investment decision.
I just found your sub stack and found it a good read.
A correction on this article though - SGB's are not taxed when purchased from the secondary market as long as they are held till maturity.