Akshaya Tritiya is considered auspicious and it is customary for Indians to buy gold on this day. Indians normally tend to buy gold ornaments and invest in gold on this day every year, leading to discounts and deals offered by vendors. Gold sales tend to go up significantly on this occasion.
Before we analyze whether one should invest in gold right now, let us first understand why it is essential to have gold in your portfolio.
Diversification tool: The idea behind portfolio diversification is that there should be very little or no correlation between financial instruments and products. Historically it has been proven that gold is a good diversification tool as it has a negative correlation with equities and fixed-income instruments.
Hedge against inflation: Gold as an asset class is considered an inflation hedge. Historically, during periods of extreme inflation, gold prices have risen and the stock markets, globally, have crashed. With high inflation, the local currency loses its purchasing power but gold tends to hold its value and rise against the domestic currency
Safe Haven Asset: Demand for gold rises during geopolitical uncertainties, pandemics, and crises as physical gold which is a high-value asset, can be easily transported, and also liquidity is such that it can be easily converted into cash in any part of the world
Liquidity: The globally accepted commodity which is bought and sold in huge volumes, can be easily converted into cash, making it liquid
Gold has been a preferred investment option among Indians not just as an investment class but for its intrinsic value. The average gold price has moved up from just Rs. 88 per 10 gm in 1947 to a peak of Rs. 62000 in April 2023.
However, the importance of gold was realized only after the 2008 global economic crisis. People around the world realized that gold can be considered a haven when other investments like equity, bond, etc. had plummeted. Till 2008, gold price was at around ₹12,500 per 10 gm but after that, there has been a steep rise in gold investments globally.
Gold prices moved during 2020 and 2021, after the discovery of Covid-19 infections. Now the gold price is again on the rise on account of rising global uncertainties.
Undoubtedly, gold provides stability to an investment portfolio. Typically, portfolio managers advise an exposure of 5 to 15 per cent to the yellow metal. Gold limits the downside risk of the portfolio in a situation when equities are not performing well.
Now that we know the benefits of investing in gold and the returns that gold has generated over the years, let us understand the technique with which one can invest in gold.
Physical Gold
Gold has been historically bought in the physical form, but if we look beyond the cultural symbolism of physical gold, we realize how wasteful it is as an investment. Physical gold carries an extra charge of 5 – 25 percent as making charges. Additionally, there is the price paid for impurities. Gold bars and coins, which are 99 percent pure, turn out to be difficult to liquidate as well, as banks, which sell them, don’t always buy them back. Besides the loss of value, physical gold brings with it the need for safe storage, with the onerous task falling on us. Even paid bank lockers don’t guarantee their safety.
There have emerged better forms of investing in gold like Gold ETFs, Sovereign Gold Bonds, or Digital Gold.
Sovereign Gold Bonds (SGB)
SGBs are government securities issued by the Reserve Bank of India. They are denominated in grams of gold and are considered substitutes for physical gold. SGBs allow investors to own gold (not in physical form) and earn interest on it. You need to pay the issue price in cash at the time of purchase and the redemption payment will also be in cash as per the current market rate of gold.
⦁ Investment – You can invest in SGB for a minimum of 1 gram of gold. The maximum limit for individuals is 4 kg and 20 kg for Hindu Undivided Family (HUF) and trusts and similar entities notified by the government.
⦁ Interest Rate, Returns, and Tenure – Investment tenure for SGBs is 8 years, premature redemption is allowed from the 5th to the 7th year. The bonds bear a fixed interest rate of 2.50 percent per annum on the nominal value.
⦁ Taxation – There are no taxes on capital gains from the redemption of SGBs if you hold them till maturity. The interest earned on the bonds is taxable as per the Income Tax Act, of 1961. For premature redemption in less than three years, investors will need to pay Short Term Capital Gains (STCG) tax as per their income tax slabs and in case of premature redemption after three years, investors will need to pay 20 percent Long Term Capital Gains (LTCG) tax. The recent finance bill has left investors uncertain about the indexation benefit for SGBs. While the bill removed the indexation benefit for debt mutual funds and ETFs, it’s unclear whether the same applies to SGBs.
Gold Exchange Trade Funds (ETF)
Gold ETFs are units that represent physical gold in a paper or dematerialized form. Investors can trade in Gold ETFs just like stocks, through a demat account and a broker. One gold ETF unit is usually backed by 1 gram of physical gold and upon selling ETFs, investors get cash and not physical gold.
⦁ Investment – You can invest for as low as 1 gram of gold and to invest in gold ETFs, you need a trading account, a share broker, and a demat account.
⦁ Charges – Gold ETFs include no entry or exit charges but there are three important costs such as expense ratio, broker cost, and tracking error. Usually, Gold ETFs incur recurring annual charges of around 0.5-1 percent.
⦁ Taxation – Gold ETF will be taxed as per your income tax slab irrespective of the holding period.
Digital gold is a virtual way of investing in 24-carat 99.9 percent pure gold that does not require actual possession of the commodity. You can buy digital gold via online payment or UPI and the seller will provide a digital invoice for the transaction within 5 minutes. The company you buy digital gold from stores the gold in its safe vault, and thus, the risk of theft is eliminated. Also, the purity of digital gold is assured as it is certified by government-licensed entities.
⦁ Investment – Digital gold investment amounts can start from Re. 1. You can sell or buy digital gold from the comfort of your home, and it offers instant liquidity without any hassle. Most platforms have a limit of Rs 2 lakh for digital gold investments.
⦁ Charges – A GST of 3% is levied on the purchase of digital gold.
⦁ Tenure – Generally, a limited storage time is provided for digital gold after which it has to be delivered physically or sold.
⦁ Taxes – If the investment or holding period of digital gold is less than 3 years STCG tax at applicable Income Tax rates must be paid. If held for more than 3 years, it will be subjected to the LTCG tax at 20 percent post-indexation benefits.
Gold ETFs are the simplest form of investment in gold. They trade on an exchange offering passive investment into gold while tracking the spot price of physical gold.
The benefits offered by Gold ETFs are unparalleled when compared with other forms of gold investment
Although ETFs attract a lower expense ratio, they still contribute to tracking errors. Tracking error is the difference between ETF returns and physical gold returns.
Tracking errors stem from the need for the fund to maintain a cash balance to cater to redemption requests. The bright side is that even with the tracking error, Gold ETFs’ features outweigh the potential costs of making charges.
Now that it’s clear why gold should be a part of the investment portfolio, the next important step is the percentage of allocation. It should be noted that there is no specific ratio or a perfect method to calculate the allocation of gold in one’s portfolio.
If one invests in gold to achieve portfolio diversification, then historically it has been seen that a 10%-20% allocation does reduce the average returns slightly, but it significantly reduces the standard deviation. A greater allocation (more than 20%) towards gold reduces the average return substantially but unlike the above situation, the allocation fails to reduce the standard deviation.
If one invests in gold from a haven perspective, there isn’t a simpler way to quantify the allocation of gold, but a wide range of 5%-20% is considered, depending upon the economic conditions.
Asset allocation decisions should just not be based on diversification benefits but also take into consideration your risk tolerance, goals, etc. As a thumb rule, a young investor with sufficient wealth and no liabilities can take on more risk and therefore should allocate more to equity and less to gold and fixed income. However, as one gets closer to achieving goals, capital preservation is important and not outperforming the index or trying to generate a high return. On the other hand, an investor who is limited by short-term goals or prefers to stay conservative with investments should focus more on preserving the capital (from the beginning) and therefore may choose target maturity funds and Gold ETFs for the portfolio.
Keeping investing simple has become very difficult these days as there are numerous resources available as well as so much noise about new and eye-catching schemes to save and invest in. Team Tavaga genuinely believes often these attractive financial products and schemes come with unnecessary risk and must be only considered after consulting a SEBI RIA. If simple investment products can take care of your financial objectives, one has to ponder whether it is worth taking additional risk by buying unregulated or high-risk instruments.
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