Gold ETF vs Gold Sovereign Bond

11 Mins

Gold is the most coveted and desired asset for Indians. The yellow metal is not just used as an asset for consumption in the form of jewellery but also for investment purposes. Investing in gold helps in diversifying an investment portfolio. It also acts as a perfect hedge against inflation risk and currency risk. However, digital gold like Gold ETFs and Sovereign Gold Bonds are acting as alternatives to gold bars and biscuits over the years. But what should you choose? Gold ETFs or Gold Sovereign Bonds. This article covers Gold ETF vs Gold Sovereign Bond in detail.

What are Gold ETFs Exchange Traded Funds?

Gold Exchange Traded Funds (ETFs) are mutual funds that invest in gold bullion. These passive investments track the domestic market price of gold. Gold ETFs are an alternative to investing in physical gold. They are in the dematerialised format. One unit of ETF equals one gram of gold which is backed by gold with 99.5% purity.

One can transact in these ETFs through stock exchanges. The purchase and redemption happen through an exchange, and hence one requires a demat and trading account to buy and sell them. These ETFs offer dual benefits of investing in gold and getting exposure to the stock market.

The purchase and sale of these ETFs happen in terms of cash and not gold. Hence there is complete transparency when a transaction takes place. Once the purchase of a unit of Gold exchange-traded fund is complete, it is stored in a dematerialised format in a demat account. Hence there is no risk of theft and no additional storing and carrying costs. The expense ratio for these ETFs is capped at 1%. However, there are also additional transaction costs and brokerage. However, unlike physical gold, there is no wealth tax and making charges.

Investing in gold helps in diversifying an investment portfolio. Also, it acts as a perfect hedge against inflation risk and currency risk.

Features of Gold ETFs Exchange Traded Funds

Flexibility: One can purchase and sell Gold ETFs online. Furthermore, they can hold them in Demat form. Therefore, the risk of storing them is nil.
Liquidity: Gold ETFs are traded on an exchange, and hence they are high on liquidity.
Price of Gold: The market price of gold ETFs is the same. It doesn’t differ, unlike the price of physical gold, based on geographies.
Smaller investments: One unit of Gold exchange-traded fund is equivalent to one gram of gold. Therefore, it is convenient for investors who wish to make small investments.
Costs: The expense ratio for ETFs is 1%. However, these do not have any additional costs such as brokerage and transaction costs if traded on stock exchanges.
Taxation: Capital gains from these ETFs are taxable on the basis of the holding period of the investment. The tax structure is different for short term and long term tenure. If they are sold before three years (short term), then the capital gains are taxable at the investors’ income tax slab rates. Suppose the investments are sold after three years (long term). In that case, the capital gains are taxable at 20.8% (including cess) after indexation benefits. And at 10% without indexation benefit.
From April 1st 2023, Gold ETFs will no longer have the LTCG benefit (as per the Finance Bill 2023). Thus, capital gains arising from Gold ETF investments from April 1st 2023, will be taxed as per the investor’s IT slab rate.

Is it worth investing in Gold ETFs?

Gold ETFs are passive investments that track the domestic prices of gold. They trade on the stock exchange are very liquid. They are considered safer than physical gold as the risk of being stolen is nil. Following are the benefits of Gold ETFs:

Simple and Open Trading: The minimum investment for this ETF is 1 unit, which is equivalent to 1 gram of gold. Buying and selling the Gold ETFs can be done on the exchange, and the prices are publicly available.
Smooth Transactions: Investors can buy gold ETFs on the stock exchange and during market hours. They can also sell them on the exchange. Therefore it is as easy as trading in stocks. Furthermore, the price of the ETF is not affected by local price differences or GST, or any other taxes.
Hedge against inflation: Gold investment acts as a hedge against inflation and currency fluctuations.
Secure: They are safe and easy to hold investment options compared to physical gold. Investors don’t have to worry about storage, theft, or bearing any additional costs for a locker or making charges.
Inexpensive: There is no entry or exit load on gold ETFs. They only have brokerage charges and fund management fees.
Portfolio Diversification: These ETFs are good options for portfolio diversification. During unstable or volatile market conditions, they help in reducing the risk.
Loan Collateral: Investors can pledge their Gold ETFs with financial institutions as a security to avail a loan.

What are Gold Sovereign Bonds?

Sovereign Gold Bonds (SGBs) are government securities that are denominated in gold. These debt securities are issued by the RBI on behalf of the government. They were launched in November 2015 as an alternative to physical gold.

One can invest in SGBs through branches of nationalised banks, scheduled private and foreign banks, authorised stock exchanges and designated post offices. They can also invest online through the authorised bank’s website. The interest on SGBs is 2.5% per annum. Since the government backs these bonds, the returns are guaranteed. The tenure for these bonds is eight years, and one can sell them on the stock exchange after a lock in period of 5 years.

Upon maturity, the redemption proceeds are automatically transferred into the bank account of the investor. Also, there is no tax on capital gains upon redemption proceeds at maturity. However, the interest is taxable as per the income tax slab rates. If, before the tenure of eight years, the bonds are sold in the secondary market, the capital gains are taxable similar to physical gold. The purchase and redemption happen in terms of cash and not gold.

The price of the gold bond is calculated as a simple average of the closing price of the last three days’ gold price of 999 purity preceding the transaction period. The gold prices will be denominated in INR. They will be the ones published by the India Bullion and Jewelers Association Limited.

Read also about the Physical Gold vs Sovereign Gold Bond

Features of Sovereign Gold Bonds

Eligibility: All Indian residents, including minors, with the help of guardians, can invest in SGBs. Also, trusts, HUFs, universities, and charitable institutions can invest in SGBs.
Investment: Gold bonds are denominated grams of gold, where one unit equals one gram. The minimum investment is 1 gram. Simultaneously, the maximum limit is 4 kgs of gold per individual investor and for Hindu Undivided Family HUFs. Whereas for trusts and entities, 20kgs of gold is the permissible limit.
Tenure and Premature withdrawals: The tenure of these bonds is eight years. After the mandatory lock-in period of 5 years, one can withdraw their investment prematurely, only on interest payment dates.
Interest Rates: The interest rate for SGBs is 2.5% per financial year. The returns are guaranteed as the government backs them. The interest payment is made on a half-yearly basis. The interest payment is over and above the capital gains from price appreciation in the yellow metal.
Taxation: The interest income from these bonds is taxable as per the Income Tax Act, 1961. On redemption, there is no capital gains tax levied. Also, the long term capital gains upon premature withdrawal come with indexation benefits.
Bond Issuance: As per the GS Act 2006, the RBI issues these bonds on behalf of the government in the form of a certificate. It can also be converted into demat form.
Authorised Agencies: One can invest in SGBs through branches of nationalised banks, scheduled private and foreign banks, authorised stock exchanges, Stock Holding Corporation of India (SHCIL) and designated post offices. They can also invest online through the authorised bank’s website.

Is it worth investing in Sovereign Gold Bond Schemes (SGB)?

Gold bonds are issued in the form of certificates by RBI on behalf of the government of India. Hence they are considered low-risk investments. They are considered safer than physical gold as the risk of being stolen is nil. Following are the benefits of sovereign gold bonds:

Safety: SGBs do not have the risk of holding physical gold. They do not have to pay any additional storage and carrying costs. Hence, they are considered safe. The only risk is the market risk which is in-built in any investment.
An additional source of income: SGBs pay a fixed interest of 2.5% per annum. Hence, they are an additional source of income for the investors.
Hedge against Inflation: Gold acts as a hedge against inflation. Hence it helps one accumulate substantial wealth over time.
Online: One can invest in SGBs through online mode. They can visit the listed commercial bank’s website and apply for the bond. Government offers an additional benefit for investors applying online. The issue price for online investors is lesser by INR 50 per gram.
Demat Account: The SGBs can be held in demat form To get this benefit, one has to make an application. Till the bonds are converted in demat format, the RBI holds the bonds in their books.
Easily Traded on the Stock Exchange: SGBs can be sold in the secondary market after five years of lock-in.
Collateral: Banks accept Sovereign Gold Bonds as collateral for loans. These loans are treated as gold loans. And the Indian Bullion and Jewellers Association Limited determines the loan to value (LTV) ratio to the value of gold.

Gold ETFs vs Gold Sovereign Bonds

The table below explains Gold ETF vs Gold Sovereign Bonds in detail:

Particulars	Gold ETF	Sovereign Gold Bond
Returns	Lower than actual return on gold	Higher than actual return on gold
Safety	High	High
Purity	High	High
Gains	LTCG after three years	Long term capital gains after three years and no tax if redeemed after maturity
Loan	One cannot avail a loan against their ETFs.	It can be used as collateral to avail a loan.
Tradability or exit formalities	Tradable on the Stock Exchange	Can be traded on the stock exchange and redeemed after the 5th year
Storage	Minimal cost	Minimal cost

You may also like to read about Sovereign Gold Bond vs Fixed Deposit

Who should invest in Gold ETFs Exchange Traded Funds?

Gold ETFs are low-risk investments as they are backed by physical gold with 99.5% purity. They are very liquid as they trade in the stock market. Moreover, they give investors an opportunity to participate in the market. Hence, investors looking for low-risk investments to diversify their portfolio and get an opportunity to participate in the market can consider investing in these ETFs. Also, investors with a long term investment horizon can invest in these ETFs to earn good returns.

These mutual funds do not have any storing costs and are more tax-efficient than investing in physical gold. Also, investing in them helps in tracking real-time gold prices with complete transparency in transactions. Hence investors who want to avoid paying wealth tax and cut down on expenses can invest in these gold funds. Moreover, these mutual funds best suit investors who prefer tracking their gold investments in real-time at a fair price.

Who should invest in Gold Sovereign Bonds?

Investors who have an affinity towards gold as an asset can consider investing in Gold Sovereign Bonds. SGBs are low-risk investment options and hence are suitable for those investors with low-risk tolerance levels. In addition to the gain in gold prices, SGB bonds also earn fixed income bi-annually by way of interest payouts. In comparison to buying physical gold, the cost of buying and selling sovereign gold bonds is lower.

Furthermore, investing in SGBs reduces the hassle of holding physical gold safely. Therefore, individuals who want to avoid such a hassle can invest in sovereign gold bonds. The chances of theft are zero as the gold bonds are held in demat form and paper form. Also, investors with a long term investment horizon can invest in gold bonds to make good returns. Moreover, they are good for portfolio diversification.