How to invest in gold

Indians decidedly have a soft spot for gold. It is not without merit, because gold works very well as a hedge against inflation and as an ‘insurance’ for your equity portfolio against stock market crashes. If you’re curious, refer to our article on what you can expect from gold which also shows you what to keep in mind when investing in gold, and how much to allocate to it. 

The first thing that comes to mind when one thinks of how to invest in gold is jewelry. But in reality, jewelry is entirely the wrong answer for how to invest in gold. There are other options that offer very efficient ways to invest in gold and capture the price movement effectively and with low costs. So, here’s looking at the different routes of how to invest in gold so you can pick the one that works best for you.

How to invest in gold

Physical gold

The most obvious way to invest in gold is to buy it in its physical form, either as jewelry or as coins or bars. And even this has moved beyond selecting a pretty design at the local jeweler. Many jewelers offer gold savings schemes to spread out the financial hit of buying a piece of jewelry in exchange for a ‘discount’.

In these schemes, you make periodic payments to the jeweler and at the end of the term, you can buy gold from the jeweler and usually, you will be given a form of a reduction in the price or installment.  But due to the several question marks surrounding the regulatory aspect of such schemes, tread with extreme caution with these schemes. 

Gold coins and bars can be purchased at jewelers, certain banks, NBFCs or even online and these can be redeemed at a jeweler or converted into jewelry at any time in the future. Another option in how to invest in gold – physical gold – is via the Government’s Indian Gold Coin scheme launched in 2015 as a part of the Central Government’s Gold Monetisation Scheme of 2015 (aimed at utilizing the gold held by households and entities and to reduce dependence on imports of gold).

By standardizing the size, design and more importantly, purity and quality of the coins and bars it offers, it alleviates some of the concerns that usually surround a purchase of gold. Recent changes to the Indian Gold Coin Scheme aim to make them more easily available, including through airports, post offices and ecommerce sites in addition to MMTC outlets.

Pros

  • Holding physical gold, especially as jewelry, partly satisfies a ‘consumption’ need in a household in addition to being considered a tool for financial security.
  • Its symbolic significance representing feelings such as prosperity is also a reason behind gold being held in its physical form.

Cons

  • Purity of gold can be hard to assess. The possibility of ending up with a sub-standard purchase is very real. 
  • Increases cost of holding gold, as safe deposit lockers are usually needed to store gold due to concerns surrounding physical safekeeping.
  • Jewelry and coins are not easily liquidated. Jewelers often prefer coins and jewelry purchased at their own stores rather than elsewhere, or may simply prefer to exchange jewelry instead of cash payouts. Two, making charges and wastage add to your cost at the time of purchase making the actual gold value at the time of sale, lower. Three, any stones embedded in the jewelry do not have monetary value at the time of sale.
  • Related to the pro above, actually selling gold jewelry is typically harder to do as it satisfies both a consumption need and holds symbolic significance.

Therefore, with physical gold, it is hard to effectively realise the market price of gold and really participate in any gold rally. Financial gold products are what you should consider when looking at how to invest in gold.

Sovereign Gold Bonds (SGB)

Also launched in 2015, the Sovereign Gold Bonds are Government securities. SGBs have a maturity of 8 years but an early exit is possible from the 5th year onwards. The issue and redemption prices of SGBs are linked to prevailing gold market prices. Therefore, through SGBs, you will be able to realise the exact movement of gold prices in the 8-year period, making them a great way to invest in gold. SGBs are issued by the RBI and you can invest in them through banks, post offices, brokerages, and more.  

SGBs are issued in denominations of grams of gold. The minimum investment is usually a gram and the maximum is 4 kilos for individuals and HUFs and 20 kilos for trusts and similar entities. A detailed FAQ on SGBs can be found here.

Pros

  • A key positive is that SGBs come with an interest component (currently 2.5% p.a. for the latest issue) that is payable half yearly on the original investment. This automatically makes SGBs a better-returning instrument than other forms of gold.
  • Another big plus for SGBs is that if held all the way till maturity for the full tenure of 8 years, the gains are not subject to capital gains tax.
  • SGBs are issued by the Government of India and therefore, well regulated compared to newer routes to investing in gold such as ‘digital gold’.

Cons

  • The main drawback of SGBs surrounds its liquidity. While an early exit is possible from the 5th year onwards, the investor would lose the benefit of capital gains not being taxed.
  • Further, SGBs are not available to purchase on demand but only whenever the Government opens the window for sale of fresh SGBs.  If one would like to buy them in the interim, then it has to happen via the secondary market. (Once issued, SGBs get listed on the exchange usually within a fortnight.) The secondary market route can also be used to exit an investment but SGBs can be thinly traded.

SGBs, with their half yearly interest and tax benefit on maturity, are well-suited for those with a long term horizon and who simply want to hold the metal as part of their portfolios. The limitations on liquidity will not be of relevance in such cases. 

Gold ETF

The other way to get a piece of the gold action is via gold ETFs. Offered by mutual fund houses, gold ETFs are passive investment vehicles that closely track gold prices. The gold ETF holds the bullion – you buy/sell units of the ETF that represent this gold. One unit of a gold ETF usually represents a gram of gold. 

Gold ETFs are traded on the stock exchange and therefore you need a demat account to invest in them. The gold ETF’s market price reflects the movement of gold prices. A list of the gold ETFs traded on the NSE can be found here.  For a detailed look at ETFs in India, metrics to use and how to use them in your portfolio, take a look at our article ‘Indian ETF options and how to choose them’.

Pros

  • Gold ETFs track gold prices closely and are very effective in allowing you to capture the movement of gold. 
  • Gold ETFs allow you to invest at specific prices and capture lows and peaks. They also allow you to invest in smaller amounts and slowly build up your gold exposure. 
  • A big plus for gold ETFs is the liquidity they offer investors as against SGBs which, despite being listed, are usually thinly traded.
  • There are no concerns about the purity of gold, unlike physical gold. ETFs can be liquidated and the money used to purchase gold jewelry, should the need arise.

Cons

  • Transactions would incur brokerage charges much like purchase and sale of stocks. 
  • You necessarily need a demat account to invest in gold ETFs.
  • Gold ETFs come with a layer of cost in the form of AMC management fees, but do note that these fees are not high. 
  • Returns from ETFs are derived only from capital appreciation unlike in the case of SGBs which also provide a stream of regular fixed income.
  • Further, these returns are taxed as capital gains (long term or short term depending on the duration for which the investment was held).
  • Low trading volumes for an ETF can distort the ETF’s market price and cause deviations between its returns and gold’s returns.

While ETFs don’t offer the fixed income component that SGBs do or the tax benefit at maturity, they score high on the liquidity aspect allowing investors to enter and exit with greater flexibility. This allows investors to ‘time’ their investments or make systematic investments.

Please note that these are not our recommendations and Prime ETFs will tell you which gold ETFs we think you should consider adding to your portfolio.

If you cannot decide between taking the SGB route or the ETF route when deciding on how to invest in gold, then our earlier article ‘Sovereign gold bonds or ETFs – which is the better gold investment’ will certainly help.

Gold Mutual Funds

The third key way in how to invest in gold question are gold mutual funds. These are mutual funds that seek to reflect the price of gold by investing in gold ETFs. An AMC’s gold mutual fund invests in its own ETF. A gold mutual fund tracks prices of the gold ETF. Like any other mutual fund, you can invest in them at any time.

Pros

  • These work like any other mutual fund and do not require you to have a trading and demat account making them a highly liquid instrument.
  • They allow you to invest with greater flexibility besides allowing investments in smaller amounts to build up your gold exposure. 
  • There are no concerns about the purity of gold, unlike physical gold. ETFs can be liquidated and the money used to purchase gold jewelry, should the need arise.

Cons

  • They involve an additional layer of cost, on top of the ETF, in managing the mutual fund.
  • The returns generated will be in line with the ETF it invests in, and any deviations between the ETF price and gold prices will therefore reflect for the fund as well.

Our earlier explainer on gold mutual funds which can be found here, breaks down all the details.

If you’re keen on investing in gold via mutual funds, PrimeInvestor’s ‘Theme Park’ will show you how you can effectively play the gold theme

Gold mutual funds are good options for those who are already investing in other mutual funds and wish to use gold as part of these portfolios. This allows for easier tracking and reviewing of portfolio performance compared to a mix of funds and ETFs. For those keen on minimizing costs, gold ETFs are a better option.

Gold mutual funds are not to be confused with mutual funds that invest in gold mining companies as stocks of gold mining companies, though related to gold prices, are not an effective alternative route to invest in gold. For a detailed rationale of what you should consider if you are thinking about investing in gold mining stocks, have a look at our earlier article here.

Digital gold

A relatively new avenue in the how to invest in gold question is ‘digital gold’ which can be purchased via e-wallets such as G-Pay, Amazon Pay and Paytm. Every time a buyer makes a purchase of digital gold, a licensed digital gold player like MMTC-PAMP or Augmont will, at the back end, buy and safeguard the physical gold. This digital gold can be sold back or redeemed in the form of coins but for this there would need to be a minimum amount of digital gold in your balance.

Pros

Easy on the pocket and therefore, makes investing in gold more accessible. The minimum investment to buy digital gold can be as low as Re. 1.

Cons

  • The digital gold space is fluid on the regulatory aspect and is not currently regulated by SEBI. Brokerages have also been barred from issuing digital gold. 
  • Cost structure is not very clear, and it offers no real advantage over gold ETFs or gold mutual funds. 

Given the absence of regulatory approval and that it does not offer any edge over the three main gold options – SGBs, gold ETFs, and gold funds – digital gold is best avoided.

How to invest in gold – a summary

  • Physical gold (jewelry, coins, bars) are the most obvious choices but challenges on purity, cost of safekeeping, price realization, and liquidity make it a very poor choice in how to invest in gold.
  • Sovereign gold bonds come with a tenure of 8 years, with added advantages of interest payouts and tax exemptions, which make for a good option for longer time horizons
  • Gold ETFs score higher on liquidity, investment flexibility and ability to capture gold price movements efficiently.
  • Gold mutual funds that invest in gold ETFs too offer similar benefits and are good options in how to invest in gold
  • Digital gold is avoidable until there is more clarity on regulations

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