What are Gold ETFs?
Gold ETFs are open-ended mutual funds that have gold as the underlying asset. Their value is based on the price of physical gold. One gram of gold equals one unit of the gold ETF. Investors investing in gold ETF have the benefit of participating in the market as well as investing in gold. Asset management companies allow investors to redeem their investments in unit form. If an investor is holding a specific value of gold in ETF form, he/she can redeem it in physical form.
Gold ETFs are traded on NSE in India and other exchanges globally. Hence, it is easy for an investor to buy and sell it on various stock exchanges globally. Some ETFs also invest in gold bullion. Gold ETFs are an excellent choice for investors who want to invest in gold for the long term to beat inflation. They come with uniform purity and no tension of theft and loss of gold.
Features
The key features of gold ETFs are:
- Flexibility: ETFs can be purchased online and can be stored in a Demat account. There is no hassle of storing them in physical form.
- Liquidity: ETFs are highly liquid as they are traded on a stock exchange.
- Smaller investments: ETFs allow an investor to buy as low as one gram of gold, which compares to one unit of ETF.
- Costs: ETF’s expense ratio is capped at 1%, and there are additional transaction costs attached to the purchase or sale of ETF.
- Taxation: Gold ETFs are taxed based on the holding period of the investment. If they are sold before 36 months, then the gains are taxed at the income tax slab rates. If the investments are sold after 36 months, then the gains are taxed at 20.8% (including cess) after indexation benefits.
Why is Gold ETF better than holding physical gold?
In India, gold is not just seen as an investment, but as an auspicious item to own. The purchase of physical gold has reduced a lot after the demonetization announcement in India. Gold ETFs aren’t capable of replacing physical gold entirely, but they have few benefits over physical gold.
- Flexibility in buying and selling: Buying gold ETFs is easier as it can be purchased through a demat account during trading hours. There are no questions on purity as ETFs invest in physical gold with 99.5% purity. Selling ETFs is also done through exchanges. Hence there is enough transparency. Buying and selling physical gold may raise questions about purity and lack of transparency. The buyer may not quote a fair price.
- No storage problem: Not only buying gold ETFs is easy; storing them is easy as well. Gold ETFs are secured in the investor’s demat account. There are no problems of theft or loss of value due to time, whereas for physical gold storage and safety are always an issue.
- Charges: ETFs have expense ratio and transaction costs, which are usually less than 1% of the value. Physical gold has making charges, and the sellers charge them at their discretion. The fees can vary from 4%-6% at the lower end.
- Buy in smaller quantities: Gold ETFs can allow an investor to buy as low as one unit (one gram of gold). While buying physical gold, one can buy smaller units, but it is usually considered insignificant.
- Transparency: Gold ETFs are traded on a stock exchange, and hence every transaction is extremely transparent. The gold price is the same across India. This is not the case with physical gold, as they are usually purchased from retailers or jewelers.
Who Should Invest in Gold ETF?
Investors who are looking for investing in gold for the long-term but do not want the hassle of physical storage and looking for tax benefits can invest in gold ETFs. Investors looking for smaller investment options can also invest in gold ETF. They can buy as low as one unit (one gram).
How does a Gold ETF work?
Gold ETFs invest in physical gold bars with 99.5% purity. These can be bought and sold anytime on the trading platform. Unlike physical gold, the prices of gold ETFs are the same across India. With a Demat and Trading account, an investor can purchase Gold ETFs on BSE/NSE. Gold ETFs attract brokerage and fund management fees.
As Gold ETFs are backed by physical gold, they are better used as an instrument to benefit from gold prices instead of buying physical gold. While liquidating Gold ETF investments, the investor is paid at the market price of the gold. Asset Management Companies (AMC) also allow Gold ETF redemption in unit form. In other words, if an investor is holding Gold ETFs equivalent of 1kg gold, or in multiples thereof, their redemption can be in physical gold form.
Benefits of Investing in Gold ETFs
- Simple and Open Trading: The minimum investment to buy a Gold ETF is 1 unit, which is equal to 1 gram of gold. Buying and selling are done on the stock exchange, and its prices are publicly available.
- Smooth Transactions: Buying and selling gold ETFs is done during market hours and is as easy as equities. Its price is not affected by local price differences or VAT or other taxes.
- Hedge against inflation: Gold as an investment can acts as a hedge against currency fluctuations and inflation.
- Secure: Gold ETFs are easy investment options compared to physical gold. There are no concerns about theft, storage, or additional costs for a locker or making charges.
- Inexpensive: Gold ETFs do not have any entry or exit loads. They only have fund management and brokerage fees.
- Portfolio Diversification: Gold ETFs are suitable for diversification. During unstable market conditions, these investments will help in reducing risk.
- Loan Collateral: Gold ETFs can be pledged as a security for loans with financial institutions.
Risks
- Price Fluctuations: Gold prices are subject to market risks, which in turn have an impact on prices of Gold ETFs. SEBI regulates Gold ETFs, and hence regular audits take place with the fund houses buying and selling physical gold.
- Low Returns: With additional charges like brokerage and fund management fees, to manage the gold ETF, the actual returns from the investment can be small.
Expense and Taxation
Gold ETFs do not have any entry or exit loads. However, the expense ratio for Gold ETFs is capped at 1%. They also attract brokerage cost, each time the units are bought and sold.
Gold EFTs are a tax-efficient way to hold gold. There is no wealth tax, no security transaction tax, and no GST. Income from Gold ETFs is taxed at the investor’s income tax slab rate when held for less than 36 months. For investments over 36 months, income is taxed at 20.8% (including cess) with indexation benefits.
Gold ETFs in India
Gold ETFs in India were first proposed by Benchmark Asset Management Company Pvt. Ltd. In the year 2002. But it was only approved by SEBI and launched in the year 2007. The National Stock Exchange (NSE) is the platform on which gold ETFs can be traded. Leading asset management companies now have multiple gold ETFs listed on the NSE to be bought and sold by investors.
Gold as an asset has always been a good investment. The returns from gold were the highest during the 2008 stock market crash. Gold is one commodity that generally acts inversely to the stock market. Over the years, the stock markets have picked up the pace, and the returns from equity were quite good. This led to falling gold prices and lower returns from gold funds. But any commodity is prone to seasonal cycles, and hence the prices of gold picked up. In 2019 alone, gold prices have skyrocketed, leading to excellent returns from gold ETFs and gold funds.
However good the returns are from gold funds or ETFs, gold can only act as an insurance cover. It is suitable for conservative investors or for those who are looking to beat inflation in the long term. Ideally, only 10-15% of the assets have to be allocated to gold. Anything more can lower the returns of the portfolio.