Looking To Make An Investment In Gold? Here's How SGB's And ETF's Stack Up Against Each Other
Physical Gold is passé - smart investors looking to take a portfolio exposure to the yellow metal are now choosing to do so via the ETF (Exchange Traded Fund) or SGB (Sovereign Gold Bond) route. After all, why jump through hoops to verify purity and ensure safe storage, when you can claim the exact same price appreciation from a hassle-free financial asset, and exchange the final maturity amount for gold at the end, if the need so arises?
The question on the minds of many gold aficionados currently, is whether to opt for Exchange Traded Funds or Sovereign Gold Bonds. While both assets are linked to the price of the yellow metal, they're quite different from each other. Let's understand them better before we can take a call on which one's best suited for your unique requirements.
Sovereign Gold Bonds
SGB's are issued by the Reserve Bank of India from time to time, in 'tranches'. These issues are announced in advance, and priced according to the prevailing rate of 999 purity gold at the time. They have an 8-year maturity period, with liquidity options starting from the 5th year. A noteworthy incentive to invest into SGB's over other forms of paper gold is the interest component attached to them. This interest - which was 2.75% per annum when the first series was launched, now stands at 2.5% for the most recent issue. Another unique feature of these bonds is the fact that although the interest is taxable, capital gains on bonds held until maturity are tax-exempt. Since the maturity value of these bonds will be linked to the price of 999 purity gold prevailing at that time, investors stand to gain significantly through this tax sop, as they'll have more money in their hands to go out and purchase physical gold, if that was the intent to begin with. The sovereign guarantee is bound to give investors peace of mind, too.
Although SGB's are exchange tradable, there's a vital catch here - their trading volumes are quite abysmal! Resultantly, bid-offer spreads are as wide as Rs. 20 to Rs. 25, and so an early exit - if at all possible - will cost you dearly. Additionally, its not likely that you'll find enough buyers on the exchanges if you need to dispose off large quantities of your SGB's in a hurry.
Exchange Traded Funds
Enter SGB's more liquid cousin - Gold Exchange Traded Funds (ETF'). ETF's are simple products that are easy to understand. Think of them as equity shares that mimic the price of an underlying asset, or basket of securities - in this case, Gold. Issued by Mutual Fund companies, ETF's can be bought and sold on stock exchanges, just like shares. The price of one unit of a Gold ETF moves in tandem price of one gram of gold. ETF's are a lot more liquid than SGB's - hence the 'impact cost' associated with large trades is much lower, and is bound to stay that was for quite some time - until SGB trading gains momentum, if at all.
This liquidity comes at a cost, of course. First, ETF's are taxed as 'non-equity' oriented mutual funds; hence, any profits arising before a three-year holding period are clubbed together with your income for the year, and taxed at the margin. Even after three years, profits do not become tax free - rather, they get indexed and taxed at 20%, just like regular bonds. Second, there's no interest associated with ETF's - its all just capital gains.
ETF's also charge you indirectly, just like Mutual Funds. The costs associated with managing and administering an ETF are clubbed together into the expense ratio of the fund, which may range from 1-1.5% - quite a steep price to pay for a passive investment!
Final Verdict
As with choices between most financial instruments, the answer depends upon what your unique requirements are. If you intend to wait for at least 8 years before realizing profits and exchanging the maturity proceeds for physical gold - say for instance, for your daughter's wedding, SGB's are the superior choice. If you're just making a tactical play for a year or two, say to hedge your portfolio of equity shares or mutual funds, ETF's are a better choice. When it comes to deciding between SGB's and ETF's allow your liquidity constraints and expected holding period to dictate your decision.
