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Gold ETFs vs. Sovereign Gold Bonds? Which one is better?

19 May, 2023
4 mins read

Saving for a rainy day is an age-old concept!

You might have heard elderly people preaching, 'Spend less, save more' in every household. Saving prudently is crucial to drift through financial calamities swiftly. It might appear odd earlier, but a crazy uncertainty like COVID-19 brought life to a standstill. And that's where the years of savings came to a rescue.

People invest in varied forms of investment to create wealth. But we Indians have always held indispensable love for the ravishing Gold and placed big bucks in it. Not only that, it has high financial value, but considered auspicious to buy Gold at weddings and festivals like 'Dhanteras'(Oct/Nov) and 'Akshaya Tritiya'(April/May).

Unfortunately, physical gold investment gets barred by certain limitations. It calls for high locker charges, making charges at the time of purchase, and may not fetch good returns.

But that doesn't make Gold investment invaluable!

Instead, the world of gold investment got redefined with the launch of Sovereign Gold Bonds (SGBs) and Gold Exchange Traded Funds (ETFs). Ease, convenience, and good returns have made them superior to physical gold investments.

However, the dilemma of deciding between the two continues. So, read ahead and decide which one is a better investment.

What are SGBs?

SGBs are government-backed securities issued by RBI on behalf of the Government of India, denominated in the multiples of gram(s) of Gold. The minimum investment permissible is 1 gram, and the maximum limit of 4kg for an individual and 20kg for trusts.

By investing in SGBs, you earn 2.5% per annum interest, along with the gold price appreciation. The bond's tenure is 8 years, providing an opportunity to exit starting from the 5th year.

What are Gold ETFs?

Gold ETFs are a commodity-based mutual fund that directly or indirectly invests in gold or gold reserves. One unit of gold ETF is equivalent to 1 gram of Gold (99.5% purity). They work like stocks and are traded similarly on the stock exchanges. Investing in gold ETFs allows you to access a gold market without buying physical Gold. The expense ratio for investment in Gold ETF is capped at 1%.

It is also a worthier alternative to physical gold investment, providing an opportunity to diversify the portfolio and hedge against inflation.

Now let's consider various parameters and conclude which is better for investing in Gold.

1. Cost-efficient.

Sovereign gold bonds are free from buying charges and not bound by any ongoing cost of ownership. However, there are no entry or exit charges for gold ETFs, but they involve an expense ratio of 1% for managing the fund and brokerage charges as trading costs. The holding cost of annual maintenance in the case of a Demat account is applicable in both cases.

Hence, SGBs are cost-efficient compared to Gold ETFs, and investors can save by investing in them.

2. Capital Appreciation and Interest Income.

SGBs offer a fixed interest rate of 2.5% per annum on the initial investment over and above the gold price appreciation. The interest is credited semi-annually, with the last interest amount credited with the principal amount on the maturity date.

However, this is not the case with Gold ETFs, which fetches only the gold price appreciation. An extra interest income in the case of SGBs makes it more attractive than Gold ETFs.

3. Tax Benefit

The capital gain on the redemption of SGBs on maturity (8 years) is exempt from tax. However, the interest earned on SGBs is taxable at the slab rates under 'Income from Other Sources.' Section 193 under the Income-tax Act, 1961 excludes the deduction of TDS on the payment explicitly  

Premature redemption of SGBs (5-8 years or before 5 years) will attract long-term capital gains taxable at the rate of 20% (without indexation) and 10% (with indexation).

Also, the SGBs can be bought and sold over the stock exchange. SGBs sold before 36 months will attract short-term capital gain (STCG) taxable at the applicable slab rates. SGBs transferred after 36 months will attract long-term capital gain(LTCG) taxable at the rate of 20%(without indexation) and 10%(with indexation).

Alternatively, in the case of the gold ETF transferred before 36 months, there will be STCG taxable at the individual slab rates. If sold after 36 months, LTCG is taxable at 20%(without indexation) and 10%(with indexation).  

4. Liquidity

Gold ETFs are easily traded on the stock exchange and are seamlessly liquidated. It is an ideal option offering a financial cushion against financial uncertainties. And this is where SGBs trail behind Gold ETFs. Redemption is possible after 5 years, but you can sell them directly on the stock exchange before 5 years. However, the liquidity is low in the initial five years.

So, liquidity is not an issue in the case of Gold ETFs, which are superior to SGBs on this parameter. However, if you want to hold the bond until maturity and liquidity is not a big concern, you can also go for SGBs.

Now your turn!

Needless to say, both SGBs and Gold ETFs are superior to conventional forms of gold investment. And hence, there is no clear winner. Both have merits and demerits based on cost, liquidity, taxation, and income generation. The choice of SGB or Gold ETF largely depends on your investor type, investment objective (long-term or short-term), and financial goals (education, retirement, wealth creation, or marriage). If you are looking for tax efficiency and capital appreciation, then SGB is meant for you. But if liquidity is your primary concern, then gold ETFs are an ideal form of Gold investment.

Make the right investment choice aligned with your financial goals!

Sovereign Gold Bonds (SGBs) are a type of government security issued by the Reserve Bank of India (RBI) on behalf of the Indian government. These bonds provide an opportunity for individuals to invest in gold without physically owning it.

Gold Exchange-Traded Funds (ETFs) are financial instruments that allow investors to gain exposure to the price movements of gold without physically owning the metal. Gold ETFs are designed to track the price of gold and are traded on stock exchanges, providing a convenient way for investors to invest in gold.

Yes, the bonds have a fixed lock-in-period of 8 years. But an investor can exit after 5 years in the primary market and can liquidate anytime in the secondary market. Premature liquidation will attract taxability.

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