Seasoned investors are always on the lookout for the best ways to maximise their returns; and gold happens to be a great investment option not only in terms of high returns but also in terms of high liquidity and price stability. If you are planning to invest in paper gold, you can do so either through Sovereign Gold Bond (SGB) or Gold Exchange-traded Funds (Gold ETFs). In case you are wondering which one of the two is better, read on.
Sovereign Gold Bond (SGB)
SGBs are government securities issued by the Reserve Bank of India (RBI). They are the substitutes of physical gold and are thus denominated in grams of gold. These bonds give you an opportunity to own gold (not in physical form) and earn interest on it. The quantity of gold for which you pay remains protected as you get the ongoing market price at the time of redemption or premature redemption.
In case you are interested in this investment option, you will need to pay the issue price in cash. The bonds will also be redeemed in cash on maturity. One of the benefits of investing in these bonds is that it can be converted into Demat form and thus can be traded on stock exchanges.
- Investment: You can invest in SGB for a minimum of 1 gram of gold and a maximum of 4 kgs for individuals and Hindu Undivided Family (HUF) and 20 kg for trusts and similar entities notified by the government. In case of joint holding, the limit applies to the first applicant. The ceiling on investment will include bonds subscribed under different tranches during initial issuance by the government and those bought from the secondary market. It will not include the holdings as collateral by lenders. When you invest in this gold investment option, an investor ID will be issued which can be used to track the total investment made by you. A holding certificate will also be issued in your name.
- Interest Rate and Tenure: SGBs come with investment tenure of 8 years, which you can encash prematurely from 5th to 7th year, to be applicable on the interest payment dates. As far as the interest rates are concerned, the bonds bear a fixed rate of 2.50% per annum on the nominal value. The interest amount will be credited to your bank account semi-annually and the last interest amount will be paid on maturity with the principal amount.
- Taxation: SGB is a great tax-saving investment option. Holding your bonds till maturity will give you tax advantage as the capital gains tax, which arises on redemption of the bonds, is exempted. The interest earned on the bonds, however, is taxable as per the provision of the Income Tax Act, 1961. Moreover, under this investment option, the government provides indexation benefits to LTCG arising to any person on transfer of bond.
Gold Exchange-traded Fund (ETF)
Gold ETFs are units that represent physical gold only in a paper or dematerialized form. They are listed and traded on the stock exchange (NSE and BSE) with gold as the underlying asset. You can trade in them just like you do in stocks, i.e., through a Demat account and a broker. One gold ETF unit is usually backed by 1 gram of physical gold. When you sell these units, you get cash and not physical gold. The price on which it is bought is probably the closest to the actual gold prices.
- Investments: To invest in gold ETFs, you need a trading account, a share broker and a Demat account. You can invest in the gold units either in lump sum or at regular intervals. You can invest for as low as 1 gram of gold. It is advisable to invest in this investment option systematically rather than by trying to time the market.
- Charges: Gold ETFs include no entry or exit charges. But there are three important costs that you must consider – expense ratio, broker cost and tracking error.
- Expense Ratio – For managing fund, the expense ratio is of 1%.
- Broker Cost – Every time you buy or sell gold ETF units, broker cost needs to be taken care of.
- Tracking Error – This is technically not a charge but it does impact returns. It occurs because of the fund’s expenses and cash holdings, thus not reflecting the actual gold rates.
- Taxation: When it comes to taxation, gold ETFs are treated like a non-equity or debt mutual funds, which comes under the purview of capital gains taxation rules. These rules are classified into two categories – Short-term Capital Gain (STCG) and Long-term Capital Gain (LTCG). STCG refers to profits made on an investment in a short duration, which is usually up to 3 years. On the other hand, LTCG refers to profits made on an investment in a long term, which is more than 3 years.
In case of STCG, the applicable tax rate depends on the tax bracket you are currently in as per the latest tax slab. Hence, if you make a profit of Rs. 30,000 on your investment and you are currently in 40% tax bracket, then your STCG would be Rs. 12,000.
In case of LTCG, the tax rate depends on whether the indexation has been carried out or not. In indexed funds, the returns are calculated after considering the effect of rising inflation. If the inflation rises, the value of your profit decreases and to reduce the loss, your tax outgo is reduced. As per the existing rules, the gains in case of LTCG are subject to 20% tax, post indexation.
Comparison Table: Gold ETFs vs Sovereign Gold Bonds
|Liquidity||High||Lock-in ends from 5th year|
|Returns||Lower than actual return on gold||Higher than actual return on gold|
|Capital Gains Tax||LTCGs applicable after 3 years||LTCGs applicable after 3 years. No capital gains tax if held till maturity|
|Collateral||Cannot be used as a collateral||Can be used as a collateral|
|Tradability/Exit Route||Tradable on exchange||Tradable on exchange. Withdrawal from 5th year|
Which One Should You Choose?
Both SGBs and gold ETFs are great investment options. Which one of the two is better for you depends on your requirements. If you want to invest in gold for long period, then SGB is good for you as it comes with a maturity period of 8 years. Moreover, investing in SGB will give you additional interest at 2.5% p.a., which gold ETFs won’t. Similarly, if you want an investment option which you can easily liquidate then gold ETFs will be the best option for you as in case of SGB, you will have to wait for 5 years for premature withdrawal.
Select the financial instrument depending on how comfortable you are at managing investments online. Furthermore, it is advisable to not invest more than 10% of your total portfolio in gold (physical or paper gold). Also, when evaluating these two investment options, keep factors such as taxation, charges and returns into consideration.