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You must have come across gold mutual funds, as a better alternative and a great way to invest in gold. So how do these funds work? Why are gold mutual funds better than physical gold? Do they have any taxation rules? Well, here’s all you wanted to know.

Gold mutual funds aim to mimic the movement of domestic gold prices. In India, gold prices are a factor of global gold price, the exchange rate, plus duties. 

 Where do gold mutual funds invest? 

Gold mutual funds

So how do gold funds reflect gold prices? They do this by investing in gold ETFs (exchange traded funds). Gold ETFs are run by AMCs. A gold ETF pools in money from large investors, and uses this to buy top-grade gold bullion. The ETF will represent this gold in terms of units. These units are listed on stock exchanges. On the stock exchange, investors can buy and sell the ETF units, indirectly buying and selling gold. 

How do gold mutual funds make returns? 

Like any other mutual fund, gold mutual funds make returns based on the movement in their underlying investment. In this case, NAV of gold funds change based on the price of the gold ETFs in which they have invested. A gold ETF’s price moves in tune with gold prices. By investing in a gold mutual fund, therefore, you are able to capture the movement of gold prices. 

When you buy a gold fund, you will be investing in gold at the prevailing rate. When you redeem, you will be selling gold at the prevailing rate. If the gold price at the time of redemption is higher than that at the time of investment, you’ve made gains on gold. 

This apart, you have dividend options in gold mutual funds where a fund may pay out dividends from time to time. however, note that a fund can pay dividend only out of realised gains; in equity or debt or hybrid funds, these gains come from interest income, dividend income on stocks, profit on selling stocks as they manage their portfolio and so on. This is harder to come by in gold, and thus gold fund dividends may be rare. 

Gold funds Vs Physical gold 

Gold mutual funds are an ideal route to investing in gold, as it allows you to capture the full price movement. They are liquid, have transparency in pricing and involve lower costs.  These factors don’t hold true for physical gold both in gold coins or gold jewellery. Usually referred to as ‘Paper gold’, gold mutual funds are the way to hold gold without all the inconvenience usually involved in the buying, storing and selling of physical gold. The table explains the benefits of financial gold over physical gold in detail.

FactorGold fundsPhysical gold
PurityOnly those of the highest purity (99.5%) are chosen and invested in. It is hard to accurately assess the purity of the gold, nor is the means to do so available to all investors 
Price discoveryReflects the full movement of gold market prices. Fund management fees for gold funds are very low at less than 1.5%.Inefficient route to capturing gold price movements. Making charges and wastage detract significantly from gold’s market price. These charges mean you pay a higher price at the time of purchase and get a lower-than-market price at the time of selling. Charges vary with sellers. Value of stones in studded jewellery are also completely ignored at the time of selling, resulting in lower realisations.
LiquidityExtremely liquid, as investments and redemptions can be done at any time easily, and proceeds come into bank accounts within 3 days.Hard to sell jewellery or coins, with discounts almost always charged on prevailing gold prices. Jewellers may not be willing to accept gold you bought from other jewellers. 
CostsLow cost. The only charges are the fund’s expense ratio, which is capped by SEBI.High costs, from making charges and wastage, as well as locker rent and other charges incurred on storage
StorageFinancial instrument, which requires no expense to ‘store’. Storing it safely is an endeavour. Bank lockers have their own high costs, along with other caveats to owning a locker than can increase costs. There are also insurances that you may have to take to cover risk of loss. 
Ease of investmentSimple and quick. Can be invested through online platforms, distributors, demat accounts, or with the AMC itself. Cannot be easily bought or sold. Different sellers have varying charges and wastage. It is vital to do your own research to find the best deal, which can tend to be quite cumbersome. 

How to use gold mutual funds in investments

Gold funds can be used as a hedge against economic shocks and equity market corrections. The price movement of gold, typically, is negatively correlated with equity markets. Gold is a ‘safe haven’ when stocks correct across the globe. International gold prices tend to shoot higher and clock strong gains when the overall risk-taking appetite in equity diminishes. This happens when there are concerns over global growth, political instability, and so on. But these periods, as can be seen historically, do not last; gold ends up losing gains made.  In risk-on scenarios, gold prices stay within a limited range or fall – in pursuit of higher returns, investors dump gold to find riskier options in equity and debt.

Gold prices move based only demand-supply pulls of equity or debt markets, and have no internal drivers on their own. They do not have any income generation capacity nor an underlying growth push. This is unlike stocks, which have underlying businesses that can grow and bonds that have interest income and react to rate changes. Therefore, very rarely is gold a compounder in the manner equity or debt is. So, expecting exceptional returns from gold exposure is not prudent. Gold is simply to protect your portfolio returns from sliding too much when equity markets correct; keeping allocation to a maximum of about 10% would be ideal.

How are gold mutual funds taxed

Gold mutual funds (and physical gold too, for that matter) are taxed based on capital gains made and holding period. If you have held the fund for at least 3 years, you have to pay tax at 20%, with indexation benefits, on the capital gain made. For a holding period shorter than this, capital gains will be taxed at your income tax slab rate.

In a nutshell, gold mutual funds  – financial gold – make for more efficient, lower cost, and better routes to investing in gold.

SEBI link for Gold funds : https://www.sebi.gov.in/sebi_data/commondocs/imdcir0206_h.html

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