Gold Exchange Traded Funds

 

WHAT IS GOLD ETF?

Gold is a commodity that is always believed to be a hedge against Inflation which means that the price of gold increases with a rise in inflation. Hence, it is always advisable to have some participation in gold for diversification purposes.

However, one should refrain from investing beyond 10% of its total investment portfolio in this asset class, as gold is a highly volatile commodity and may erode your portfolio in case of downslide.

The price of gold is mainly influenced by the below factors –

• International price of gold
• Dollar exchange rate
• Local taxes
• Local demand and supply mechanism

The most common forms of gold that are available for investors are mentioned below:

1. Physical Form – This is in the form of gold ornaments, coins, bars, etc. It is freely available at banks, jewellers shops etc.

 

2. Gold Saving Funds – This form is available with mutual fund houses. Those who invest in gold saving funds get units of mutual funds and the funds are invested in buying gold ETF and into companies that are directly or indirectly associated with gold processing. Eg are gold mining companies, companies making gold ornaments etc.

 

3. Gold ETF – Gold ETFs are as good as physical gold. The only difference is, it comes in paper form, is more cost-effective and rules out all limitations of physical gold. One has to open a “Demat account” with any registered stockbroker to buy this form of gold and can buy units of gold from the stock market.

 

4. Sovereign Gold Bonds – This is the most popular form and favorites of most gold investors as this is the only form of gold that pays interest every year.

These Bonds are issued by Reserve Bank on behalf of the Government of India and substitutes for holding gold either in physical form or Demat form.

Investing in these bonds is very simple. Investors can just walk in any nationalized banks like State Bank of India and scheduled private banks, Stock Holding Corporation of India (SHCIL), designated post offices and the National Stock Exchange of India and the Bombay Stock Exchange and make an application.

In this article, we are going to discuss about various aspects of investing in “Gold ETF”.

 

 

IMPORTANT POINTS TO NOTE ABOUT GOLD ETF

The following are some of the important features of the GOLD ETF that every investor must know.

1. Investor’s profile – It is best suited to investors who want to invest in buying gold, can stay invested for a minimum of 5 to 7 years and have a very high-risk appetite to be able to digest even loss of principal.

 

2. Risk – Gold is considered to be the high-risk high returns investment. Sometimes, it can also result in negative returns or risk of principal loss.

 

3. Liquidity – Gold is considered low on liquidity due to its volatility. However, accessing funds during emergencies is possible as gold ETF is listed on the stock exchange and can be sold in the secondary market for which investors need to find a buyer.

 

4. Taxation – Income earned from gold bonds is considered as “Income from capital gains” and is subject to long term capital gains tax if sold after 36 months and qualifies for indexation benefits. On the other hand, interest earned out of such bonds is treated as interest income and taxed as per applicable tax slab. Gold investment does not provide tax benefits.

 

5. Volatile – Returns from gold are market-linked which makes them highly volatile.

 

6. Time horizon – Gold is suitable for investors having a time horizon of at least 5 to 7 years.

 

7. Regular Income – Only “Sovereign  Gold Bonds” offer regular income in the form of interest @ 2.75% per annum which is paid every 6 months. “Gold ETF” does not generate regular income.

 

8. Returns – Since it is market-linked, its returns are not fixed as it is linked directly to the price of gold.

 

9. Asset class – Gold ETFs are a substitute for holding physical gold.

 

10. Cost – Physical gold is subject to huge making charges, whereas gold savings funds on the other hand are mutual funds products and are subject to “Expense ratio”. Gold ETF is subject to brokerage. However, “Sovereign Gold Bonds” are issued by Government on India, and they do not involve any additional cost of investment.

 

11. Loan facility – In case of emergencies, investors can pledge their gold units as collateral to avail loan facility.

 

 

WHO CAN INVEST IN GOLD ETF?

Gold is an open investment scheme and is freely available to anyone and everyone except in the “Demat” form where one needs to update their KYC documents with the registered broker.

 

 

WHAT KIND OF RETURNS CAN GOLD ETF GENERATE?

This asset class is expected to generate average returns of 6% to 15% in the long term.

Gold has generated the average returns of approximately 9% in the last 10 years.

Assuming, you invest Rs. 10,000/- per month until retirement (60 years) @ average rate of 9% per annum, the corpus you will create (approximately) on your retirement i.e. at the age of 60 at various age groups will be as follows:

Returns generated by gold in the last 10 years in comparison to Sensex

 

 

FUND ACCESSIBILITY AND LOCK-IN APPLICABLE FOR GOLD ETF

“Gold ETF”s do not have any lock-in hence investors can exit and access their funds anytime. However, though it is possible, it may not be financially viable to access funds at all times due to the high volatility involved.

It should also be noted that gold is meant for long term investment due to its volatility and short term investors should take a dip after careful evaluation of risks involved.

 

 

 WHAT ARE THE BENEFITS OF INVESTING IN GOLD ETF? 

GOLD ETF offers the following benefits to its investors.

1. It provides inflation-adjusted returns in the long run – Gold is known for generating returns that are good enough to beat inflation in the long run. There is a direct relationship between gold with inflation which means the price of gold increases with the rise in inflation.

 

2. Hedging against slowdown in equity markets – Gold has an inverse relationship with equity investments. Hence, if the equity market underperforms and your equity investment portfolio loses its value, gold can cover up for losses to some extent.

 

3. Tax-efficient – Returns generated from selling gold are termed as “Income from capital gains” and long term gains qualify for indexation benefits.

 

4. Lower Cost – The biggest advantage is on the cost front when compared to buying physical gold in the form of jewelry. The making charge of 20 -25% reduces to as low as 1% in the form of brokerage in case of “Gold ETF”. “Sovereign Gold Bonds” on the other hand pay interest for investing in gold.

 

5. Easy access to funds during hard times – Gold is highly liquid. During emergencies, it can be liquidated without any hassle whenever needed. However, redeeming it during unfavorable market conditions may result in losses. Hence, one should refrain from investing in gold if they anticipate any expenses which may trigger redemptions.

 

6. Extra returns – With capital gains, sovereign gold bonds also offer regular payment of interest which enhances its investment value.

 

 

 WHAT ARE THE LIMITATIONS OF INVESTING IN GOLD ETF? 

GOLD ETF has the following limitations.

1. No regular income – Gold investments do not pay regular dividends and hence do not generate any recurring income except interest earned from “Sovereign Gold Bonds”.

 

2. Highly volatile – Gold as an asset class is highly volatile and fails to generate predictive or indicative returns. It makes this asset class highly illiquid when the market is unfavorable.

 

3. Risky – Its volatility makes it so risky that investors are exposed to a risk of losing their principal.

 

4. Low Liquidity – Gold being a highly volatile asset offers low liquidity in short term.

 

5. No guaranteed returns – Inspite of being invested for the long term, its returns are not guaranteed and are unpredictable in the long run.

 

 

WHO SHOULD CONSIDER INVESTING IN GOLD ETF?

GOLD ETF is most suited to the following investors:

1. Gold Lovers – Gold investors must avail the option of buying gold in digital form as it is not only a safe and more secure way to invest in gold but also more cost-effective and easy to maintain.

 

2. Risk-takers – Young investors especially below 35 years of age, who have age by their side and can take higher risk and can stay invested for a longer term can consider investing in gold ETF.

 

3. Investors who want to diversify – Investors with low liquidity needs, have enough exposure to debt and equities and looking forward to diversifying their portfolio must consider investing in this option.

 

4. Investors having long investment horizon – Those investing for long term goals like retirement planning, children education, etc. where they do not foresee the need to liquidate this investment in short term.

Someone who is anticipating fund requirements anytime soon and foresee a possibility of liquidating it should avoid investing in gold.

 

 

WHO SHOULD AVOID INVESTING IN GOLD ETF?

GOLD ETF may not be the best investment for the following investors:

1. Investors with high liquidity needs – Gold as an asset class is highly volatile hence frequent withdrawal at regular intervals is not possible during market downslide. Hence investors with high liquidity needs should avoid this asset class.

 

2. Conservative investors – Due to the high volatility involved, investors with a low-risk appetite should refrain from investing a large amount in it.

 

3. Investors looking for regular income – GOLD ETFs do not generate a regular income for its investors. Any price appreciation in the value of gold is paid when the units are sold.

 

 

A PIECE OF ADVICE

THINGS YOU SHOULD DO WHILE INVESTING IN GOLD ETF

GOLD ETF investors must follow the below suggestions while investing to maximize the value of their investment.

1. Perform due diligence – Investors should be aware of all pros and cons of the investment they are getting into. The amount required on maturity, liquidity needs, risks involved, etc. should be carefully assessed before signing up for this scheme. Also, as mentioned above, there are various ways of investing in gold hence, the option that works best for you should be considered.

 

2. Know your investment goal – One should do a careful evaluation of their investment objective while choosing investment products. Investment in gold is mainly meant for long term financial goals having a horizon of 5+ years.

 

3. Assess your risk appetite – One should always assess their risk appetite before investing in gold. Gold is considered as a high risk – high return investment. And someone with moderate income, sole bread earner of the family, low on savings, high on liabilities tend to have a very low-risk appetite, and even a minor loss may derail their entire financial life. Such individuals should be very careful while investing in this option.

 

4. Cost of Investment – Different forms of gold investment involves different cost. Like gold mutual funds and ETF are subject to a fee called an “Expense Ratio” and “Brokerage”. Physical gold is subject to a cost called “Making Charges”. “Sovereign Gold Bonds” is the only method that pays interest and has a backing of the government. Hence, all these details should be carefully evaluated before making a choice.

 

5. Always diversify – Never put all eggs in one basket. The safest way of investing is to diversify your investment across various asset classes as the fall of one asset class sometimes leads to the rise of another. Concentration on one particular asset class can be very risky and may result in loss of capital. Similarly, refrain from over diversifying the portfolio as it may dilute your overall gains.

 

6. Update nominee details – Updating nominee details at the time of investing is very important. In case of an investor’s death, the family members should not end up running from pillar to post when they need that money the most to claim your investment proceeds.

 

 

THINGS YOU SHOULD AVOID DOING WHILE INVESTING IN GOLD ETF

GOLD ETF investors must avoid indulging in following practices while investing to protect their investment from losing its value.

1. Looking at it as a sole investment vehicle – Gold is a commodity whose performance is market-linked. Though it is known for generating inflation-adjusted returns, it is not guaranteed. In some cases, investors have even lost their principal. Hence, it should not be used as a sole investment vehicle but as an option to diversify your investment portfolio.

 

2. Going heavy on this asset class – Gold is a highly volatile asset hence, exposure of anything over 10% of the total investment portfolio may put you at high risk of low or negative returns.

 

3. Borrowing money to invest – A lot of brokers or agents will lure you with attractive returns however, one should understand the risk involved in Gold.

How much ever promising the investment looks, one must be very careful about fundraising methods. Never borrow money to invest in risky options as a minor miscalculation can lead to heavy losses where all your money can vanish if the investment fails.

 

4. Do not get influenced by anyone but financial experts – A confused investor always has a tendency of reaching out to their friends and relatives for suggestions while making critical investment decisions. That happens irrespective of the knowledge and the level of understanding the friend has about the domain. It is as good as asking a truck driver, how to fly an airplane. Such advices in most cases are based on their individual experiences and hardly on calculations or facts and figures. Hence, instead of blindly following the financial advice of a random friend, investors must act wisely and take assistance of a well qualified financial planner who has sound knowledge about the domain.

 

 

 WHAT ARE THE RISKS INVOLVED IN GOLD ETF? 

GOLD ETF investors should be mindful of following risks involved in this investment:

1. Market Volatility risk – Returns on gold are market-driven and are largely influenced by various macro and microeconomic factors where we have almost no control. This makes this option highly volatile and risky.

 

2. Credit risk – The performance of gold is largely driven by various market forces like the international price of gold, dollar rate, demand for gold in the domestic market, local taxes, etc. which makes this asset class highly volatile and risky including the risk of principal loss.

 

3. Concentration risk – Returns from gold are solely determined by the future value of gold due to which the fate of investors is largely dependant on the performance of one particular commodity. This increases their exposure to risk due to over-concentration on a single asset class.

Limiting the exposure to gold to 10% of the total investment portfolio and diversifying investment across can help investors mitigate risk and also earn decent returns.

 

4. Liquidity Risk – Though money invested in gold can be withdrawn anytime, sometimes it is not financially viable to exit when the markets are on low. Doing so may lead to losses. Hence, one cannot rely on gold for their liquidity needs.

 

 

TAXATION RULES FOR GOLD ETF

Earnings from the sale of gold is treated as the “Income from capital gains”. Hence, if the units of gold are sold before 36 months then the gains will be treated as short term gains and will be added to the total taxable income and taxed accordingly.

On the other hand, if the units of gold are sold after 36 months, then gains will be treated as long term capital gains and taxed at the rate of 20% after indexation.

 

 

HOW TO INVEST AND DOCUMENTS NEEDED

Traditionally gold was available only in physical form. Physical gold had its set of limitations like the high cost of maintenance, making charges, risk of theft and burglary, purity issues, etc.

However, nowadays with the latest developments, gold is also made available in paper form. With this, all the above limitations are taken care of. One can invest in paper gold in the following ways.

1. Gold ETF – To invest in gold ETF, one needs to open a Demat account where all the units of gold will be credited.

To open the Demat account, one needs to approach a registered stockbroking house with their KYC documents(Photo, Pan card and address proof), fill up the application form and once the account is active they can start buying units of gold ETF.

 

2. Gold Saving Funds – One can invest in “Gold Saving Funds” via mutual fund route, where they can buy units of mutual funds which in turn will invest in Gold ETF and other companies directly or indirectly related to gold.

For this, no Demat account is needed however, an investor still has to open an account with a registered mutual fund broker or mutual fund house and provide KYC documents.

 

3. Sovereign Gold Bonds – These Bonds are issued by Reserve Bank on behalf of the Government of India and substitutes for holding gold which can either be held in physical form or Demat form.

It involves the risk of capital loss if the market price of gold declines. However, the investor does not lose in terms of the units of gold that he has paid for.

Investing in these bonds is very simple. Investors can just walk in any nationalized banks like State Bank of India and scheduled private banks, Stock Holding Corporation of India (SHCIL), designated post offices and the National Stock Exchange of India and the Bombay Stock Exchange and make an application.

The application form can also be downloaded from the RBI’s website.

Payment for the bonds will be through cash payment (up to a maximum of Rs 20,000) or demand draft or cheque or electronic banking.