Should you invest in Sovereign gold bonds or gold ETFs?

Sunita is a working woman nearing 50, who wants to set aside some gold for her daughter’s wedding. Her banker friend has told her about sovereign gold bonds and gold ETFs as substitutes for physical gold. While the gold ETFs have been around, the bonds are fairly new in the market. They are issued by the Government of India in tranches and in various denominations. The amount invested will be redeemed at the price of gold at that time in about eight years. Sunita is wondering if she should invest in the bonds or ETFs.

Both the gold bonds and ETFs will allow Sunita to invest in gold on paper, rather than buy physical gold. But she must remember that even though the gold bonds are backed by the Government of India, the returns are linked to price movements in gold, and are therefore not guaranteed. In this respect, both ETFs and sovereign bonds carry similar market risk. The values of the gold bonds and ETFs are based on the gold price of .999 purity and .995 purity respectively.

A key differentiator for sovereign gold bonds is the feature of an additional interest of 2.75% per annum, which is computed based on the investment value of gold. This interest on the gold bond is accumulated over and above the appreciation in the value of gold. Further, the costs involved in ETF investments ( demat charges, brokerage and expense ratio) would essentially lower Sunita’s investment amount, and in turn, her return.

In order to mitigate risks from any steep price corrections closer to the redemption date, the bonds would provide Sunita the option of rolling over her investment for a further period of at least three years. If Sunita were to redeem these bonds at maturity, her capital gains would be tax-free. However, in terms of capital gains arising out of trading, gold bonds and ETFs are on a level playing field. The interest income earned from the bonds will be subject to taxation, similar to a bank deposit. However, no TDS is applicable to the interest earned from these bonds.

Since Sunita intends to save for her daughter’s wedding, the bonds are the better option for her, because they will allow her to accumulate gold at a lower cost, with additional interest and tax benefits. However, if she wants to buy smaller denominations than a gram, she would have to opt for gold ETFs. Either way, her investment will be subject to market risks.

(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)