Is it Worth Investing in Sovereign Gold Bonds?

As the gold price looking up this year their is reverence among people for gold that it is beyond its market value.

Sovereign Gold Bonds (SGB) are one such alternative, offered by the Government of India and RBI with an opportunity to invest in gold as an alternative to owning gold in the physical form. Also, it belongs to the debt fund category.

Features

These bonds have tenure of 8 years and come with a sovereign guarantee (negligible risk of default that is). The nominal value of these bonds is fixed on the basis of simple average of the 3 day closing price (preceding the subscription period) of gold of 999 purity.  So, at current prices, the issue price is likely to be fixed at about Rs 4,700 per gram. At the time of redemption, one gets an amount equal to the (then) prevailing gold prices and grams of gold owned. 

In addition, these bonds bear a fixed interest of 2.5 per cent on the initial investment – which is payable semi-annually. 

Better than physical gold

SGB is a superior alternative to investing in physical gold be it in the form of coin or jewellery. While buying jewellery, one incurs making charges which could be anywhere from 5% to 20 %of the jewellery cost. When you sell it back to the jeweller, you lose out on these charges. Moreover, there is a worry about purity and safe storage of physical gold. 

Whereas, SGBs, as well as gold funds, let you own gold in paper form, without worries about its purity or making charges. While SGB does not charge anything, gold funds have an average annual expense ratio of 0.5%. 

Liquidity challenges 

The bond has a tenure of 8 years with the option to surrender it early in fifth, sixth and the seventh year. However, on exiting early, investors lose out on tax advantages. 

While the SGBs are also listed on the exchanges within a fortnight of its issuance, it is traded infrequently. Earlier bonds are currently quoting at a discount of up to six percent to prevailing gold prices. 

In times of Covid, when businesses and jobs look vulnerable, it is prudent to keep ample liquidity. Investing in bonds with huge lock-in might not be a wise option now.Whereas,Gold funds tend to be highly liquid and can be redeemed quickly.

Tax treatment

Appreciation in bond value (based on gold price movements during the tenure) constitutes the capital gain. There is no tax on capital gains made from investing in SGBs, if held till maturity. However, there is 20 % tax (along with indexation benefits) if redeemed prematurely after three years or more. Similarly, capital gains from investing in gold funds for three years or more entails a 20 % tax along with indexation benefits.

Moreover, the interest earned on the SGB investment every year is subject to taxes at the marginal rate. 

Gold as an asset class

The equity market has corrected sharply this year with the spread of Covid-19 virus in the country. Falling interest rates, in turn, has reduced the returns from fixed income instruments. On the other hand, gold prices are up by 22% this year.

Historically, gold prices have shot up during economic crisis or upturn of political tensions, thanks to its safe-haven status. However, gold has earned the bulk of its returns from rupee depreciation and not from the appreciation of its permanent value. 

Unlike equities, their price movements are more unpredictable and sometimes gold investors have to keep waiting for a longer time. For instance, investors who had bought gold at the peak in 1980 would have had to wait for 27 more years just to see its prices get back to the same level.Investors are better off treating gold as a small part of their portfolio. They could consider investing in a mix of SGB and gold funds if need be.

In tough times like these, liquidity is vital. Investors are better off avoiding instruments that have lock-in. Gold at best can be a small part of your portfolio and no more.

You can use GIIS Financial tools or Our Android App  for Investment, tracking and Asset allocation planning. 

*Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

Share On