Indians have always coveted the glitter of gold. That desire has stood the test of time, despite challenges from newer financial instruments that promise to deliver better returns.
This is visible in the latest data from the World Gold Council. In its report, Gold Demand Trends 2023, it said Indian gold bar and coin demand rose 7% year-on-year in 2023 to 185 tonnes, while jewellery demand dropped 6% to a still substantial 562.3 tonnes. However, physical gold-backed exchange-traded funds hit a record of 42 tonnes by year-end.
One reason why gold has remained a popular asset is its traditional role as a hedge against inflation. Besides, adding gold to portfolios can help with diversification. Considering this insatiable demand, multiple forms of gold investments have been introduced over time: from minted products (coins and bars), gold bonds, and digital gold to gold exchange-traded funds (ETFs) and mutual funds.
Each of the options comes with its advantages and drawbacks. Physical gold risks theft and burglary, while gold ETFs and bonds have custodian risks and others not present with physical gold.
The avenues
Physical gold—gold coins, jewellery, and bars—can be purchased from a jeweller or a bank. The advantage here is that you have direct ownership, plus it holds sentimental value for many Indians. But one must consider the associated risks here, like storage, safety, making charges, and the risk of receiving less than the market value when sold.
Vikas Singh, MD & CEO of precious metals processing firm MMTC-PAMP, says, “Minted products provide tangible ownership, can be held for long durations, are passed down generations, and hold deep cultural significance. Minted gold and silver products are some of the most preferred forms of investment.”
Next comes digital gold. As the name suggests, investors can buy, sell, or hold gold in a digital format. Like buying physical gold, with digital gold, you own the gold you purchase. The metal for each transaction is stored in insured vaults monitored by a trustee. There are no storage costs here, and investors can buy or sell 24/7. But these transactions attract goods and services tax (GST) and other charges, which affect the overall returns.
Ajinkya Kulkarni, Co-founder and CEO of fixed income product platform Wint Wealth, says, “Digital gold is still an unregulated space. Hence, investors should avoid it, even if a company offers them cashback or other rewards. It is also inefficient from a taxation point of view, since investors need to pay a 3% GST charge when buying digital gold. For example, if someone buys `1,000 worth of digital gold, she only receives the gold equivalent of `970 in her digital account. The capital gains on digital gold are taxed on par with physical gold.”
Then follow sovereign gold bonds, or SGBs—government securities expressed in grammes of gold, providing an alternative to possessing physical gold. Investors are required to make the payment in cash at the issue price, and the bonds will be redeemed in cash upon reaching maturity.
There is no buying or redemption cost on SGBs if purchased in the primary market and held till maturity. It also fetches a 2.5% interest per annum, taxed at slab rates. Even the capital gains on SGBs are tax-free if held until maturity. Though SGBs are listed on stock exchanges, liquidity could be challenging. They can be bought online through the website of scheduled commercial banks.
And last, there are gold ETFs that directly invest in gold, and the units of these ETFs are listed on stock exchanges. Gold ETFs provide a more transparent way of investing in gold compared to the other two formats. It can be bought or sold at market-linked prices, involves no storage, and is highly liquid. But it also requires a demat account and attracts brokerage charges and a nominal expense ratio.
Gold ETFs help resolve concerns over purity, storage, and liquidity. The ETF units are stored in your demat account. You can buy as much or as little as you want from asset management companies, hold your units for any length of time, and sell when you’re ready.
Cost factor
In reviewing the costs tied to digital gold, gold ETFs, and physical gold, one should also bear in mind how these may influence long-term yields. Let’s delve into each option.
Digital gold platforms usually charge a fee for the purchase, sale, or deposit of gold. There can also be transaction fees, management fees, or service charges. These costs can erode overall returns on investment. It is crucial to know about these charges and make an informed comparison between different providers before investing in this instrument.
Gold ETFs entail a different expense structure, which commonly includes expense ratios that reflect the management cost of the fund. Transactions on the stock exchange might attract additional brokerage fees. High expense ratios can depreciate returns over time. Therefore, Col (Retd.) Rakesh Goyal, Founder and CEO of Let’s Invest Wisely, advises investors to choose ETFs with lower expense ratios and avoid frequent transactions to minimise brokerage costs.
Lastly, acquiring physical gold entails making charges and GST. Goyal says there will also be additional costs for secure vault storage. Notably, transaction costs associated with physical gold are comparatively higher than those associated with digital gold and gold ETFs.
Another important factor is taxation, and each option has different implications. For example, gains from digital and gold ETFs may attract a capital gains tax, while physical gold may attract GST on purchase and capital gains tax on sale. Under the Income Tax Act, typically, a 20% tax on long-term capital gains (LTCG) plus a 4% cess, totalling 20.8%, is applicable on the sale of gold. Capital gains from paper gold, including gold mutual funds, gold ETFs, and SGBs (if sold before maturity), are subject to a 20.8% tax on long-term gains. For a holding period under three years, short-term capital gains (STCG) tax applies based on the individual’s income slab. However, gold ETFs bought after March 31, 2023, will incur short-term capital gains tax at slab rates, regardless of the holding duration.
Adhil Shetty, CEO of BankBazaar.com, says, “According to Section 56(2) of the Income Tax Act, gold gifts from parents, spouses, or children are exempt from income tax. However, gifts from non-relatives exceeding `50,000 are taxed under the income from other sources category. While gold jewellery received as wedding gifts may be tax-exempt, selling these gifts attracts capital gains tax. It’s essential for individuals to be cognizant of these tax implications when entering into gold transactions or receiving gold gifts.”
In the case of physical gold, 3% GST is applied while buying, plus making charges for jewellery. There is no GST on gold ETFs, gold funds, and SGBs.
Regulatory frameworks, too, play a pivotal role. Physical gold is often subject to local regulations, while gold ETFs fall under market regulations. Gold ETFs are regulated by the Securities and Exchange Board of India (Sebi), while gold bonds are regulated by the Reserve Bank of India (RBI). But there is an absence of regulation on digital gold.
That aside, among the various avenues, digital gold and gold ETFs offer higher liquidity than physical gold. They can be bought and sold swiftly on platforms. In contrast, physical gold transactions involve more time and effort.
Risk factor
There are primarily three risks associated with digital or ETF-based gold investments. “Both gold ETFs and gold mutual funds share a common risk, primarily tied to market fluctuations stemming from the potential volatility in gold prices. On the other hand, SGBs introduce a different risk factor: sovereign default risk. This risk arises because SGBs are not directly backed by physical gold; instead, they represent a derivative of gold issued by the government through the RBI,” says Shetty.
Counterparty risk: When you invest in digital gold or gold ETFs, you are exposed to counterparty risk. This means that the value of your investment is dependent on the financial health of the entity that issued the product. If the issuer goes bankrupt, your investment will be impacted. In contrast, while owning physical gold you have direct possession of the asset, eliminating counterparty risk.
Custodial risk: In digital and gold ETFs, your gold is typically held in custody by a third party. There is a risk associated with the security and reliability of the custodian. If the custodian faces operational issues or fails to safeguard the gold properly, it could jeopardise your investment. In physical gold, you have direct custody of your investment. But you still need to ensure proper storage and security measures to protect against theft or damage.
Tracking Error: ETFs may not perfectly track the price of gold because of factors like management fees, tracking errors, and market conditions. This means that the value of your investment might not precisely mirror the movements in the price of physical gold.
The value of physical gold is directly linked to market prices, and there is no tracking error here. However, selling physical gold may involve transaction costs and may not be as convenient as selling ETF investments.
Which is better?
The growth of digital gold and gold ETFs reflects evolving investor preferences for convenience and accessibility. But there is no one-size-fits-all answer in terms of which avenue is the best, and investors will have to use discretion while making the choice. It must be based on an analysis of which option aligns best with the investor’s specific needs.
Physical gold can serve as a meaningful heirloom to be passed down through generations or used personally. Digital gold is best for minimal investments or to avoid any issues regarding the metal’s storage and purity. And gold ETFs are great for diversification. Shetty of BankBazaar cautions that gold is a conservative investment, and its returns just about outpace inflation. There can be periods where returns could be flat or negative. It would be wise to allocate about 10% to gold in a portfolio.
Thus, investors should choose the type of gold investment as per their short- and long-term goals. For those interested in preserving wealth, physical gold might be the best choice. If liquidity and cost-effectiveness are more important, then digital gold and gold ETFs may prove more valuable. It is important to have a well-balanced portfolio that weighs the pros and cons of each gold investment option. Kulkarni of Wint Wealth suggests that gold ETFs are best for short-term sellers as they can be bought and sold during stock market hours.
Whatever the option, investors should think long and hard about the avenue that best suits their needs.
@imNavneetDubey
