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My mother is the best investor I know. I have heard people speak a great deal about Equity, Debt, and even Real Estate but nothing beats gold. Gold ETF has grown at a CAGR of 11.72% and Nifty’s TRI (returns inclusive of dividends) has been about ~8.5%. However, there is something that this debate misses out on is taxation on Gold.
Just like shares (Listed and Unlisted) there are nuances to be understood when investing in Gold, as there are multiple ways to make investments.
Physical Gold
Gold ETF
Sovereign Gold Issued By RBI
Physical Gold
We love physical gold. We use gold for weddings, the first birthday of a child, and at various events. You just need a reason and Indians will buy gold. It is passed on for generations, and we make our gods wear them. We even have a Golden Temple. Generally, people don’t like to sell the jewelry they have purchased. It is considered to be a safe haven for bad times. We have entire business houses that have created lending businesses based on Gold pledging. It is our bellwether asset, to safeguard our world.
However, when we keep the jewelry there are also the making charges involved and in addition, gold has some holding cost. Let’s say a lot of it is kept in Bank Lockers (No traceability to the income tax departments unless they raid your house). Additionally, when we are purchasing gold in white (Cheque), we have to pay 3% as GST. When we sell it, that 3% is used considered to be part of the cost and no additional benefit is given.
In case you wish to sell the gold, capital gain tax is charged. If you choose to sell the gold within 36 Months it will be classified as short term capital gain/loss and your slab rate will be the tax rate.
In case you choose to hold the asset for more than 36 months, then the tax rate is 20%. Income tax also provides you with indexation on the purchase price. Think of indexation as inflation adjustment of the purchase price which will effectively reduce your tax charged. Mind you, the jewelers will pay you only for the gold, not even the making charges, and you will even not recover the GST you paid. So if you plan on selling then purchase bricks only.
What I have failed to mention is the convenience yield of gold. Once you have the gold bricks, without selling them and paying taxes you can convert it directly to jewelry. In other modes, that won’t be possible. Jewelers' charge is a lot of money. But ‘Sona hai sada ke liye’.
Gold ETF
Now suppose, instead of giving you gold I give you an e-invoice of the gold you have purchased. I keep the gold on your behalf and charge you nominally for that. I also tell you, whenever you want to sell the gold just click on a button and you will get your money back in your account in no time. You do not have to hassle with the Jeweler if 99.99% pure or not, or if it is 20/22 or 22/22 or 18/22 carat gold or anything else. I will give you your money back. This is what Gold ETF is. It traces the market price of gold and the best part is that you can put in as less amount as you like. This ETF is managed by the Mutual Fund houses, for that, they charge nominal expenses which can range from 0.1% to 0.55% (HDFC Gold Fund). Some argue generally, we keep gold in Bank lockers and since we are paying money there why don’t we pay nominal charges here. Absolutely true but just for perspective, one small size locker (4.75*5.8*15 inches) which costs about INR 3000 per year can hold more than 100 kgs of gold. 1 Kg of gold costs about INR 50 Lakh. For 1 kg gold, you will have to pay at least INR 5000 going by the current rates.
The only advantage gold ETF seems to be having over physical gold is the fact that the 3% GST one pays in case of physical gold is recovered in the ETF. However, in the long run, that amount might not mean a lot.
From the tax perspective, taxation is similar to what you will have to pay in the case of physical gold. I have put in an analysis of how your returns would look like in case you purchase 10 gm gold when the market rate is INR 50K. So you will have to invest INR 51,500 for 10 gm. I have compared it with investing INR 51,500 in the gold ETF.
The returns in the case of a direct plan in Gold ETF seem to be beating the returns from physical gold. However, one should not discount the convenience yield. I do not know any place where making charges of jewelry is less than INR 280/ gm (We have known the jewelers for decades now). Adding that into the equation, things won’t look very rosy.
How your 10 gms of gold will be valued, wherein you have invested INR 51500 in each of the avenues. I have assumed that the value will grow at a rate of 10% per annum.
Sovereign Gold Bond
I like this mode of investment the most. It is similar to an ETF but the difference is that it is issued by the RBI and the government owes you the money, not the banks. RBI from time to time issues gold bonds that trace the market like any other Gold ETF. However, the best thing about these bonds is that RBI gives 2.5% paid twice on the nominal value (Initial Investment value). Also, there are no maintenance charges as charged by the Mutual Fund houses. Generally, the tenor is 8 years. However, one thing they also lack is the convenience yield.
When it comes to taxation, they are pretty awesome. If you hold them till maturity then no taxation on capital gain, otherwise if you sell it before redemption then the normal capital gain tax would apply.
On interest earned, one would have to pay tax as per the income tax slab rate.
One thing we have not covered in this piece is what people do when they purchase gold in cash, and why do people purchase gold in cash, and how that gold rotates in the economy. That is a conversation for some other day.
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