Go for gold funds to tackle uncertainties

Manish KothariPaisabazaar.comGold has been considered as a precious metal since the start of human civilization. It is used in ornaments, as well as an asset or investment by some to be passed over to next generations. It also provides a sense of security, especially at the time of financial crisis. We may choose to invest in gold in various forms – physical gold, sovereign gold bonds, gold ETFs (exchange traded funds), gold funds, gold futures, etc. As all these instruments have their specific advantages, it is important to understand them before closing in on a particular instrument type. But before that, let’s understand why you should include gold in your investment portfolio.Why is it important to hold gold?Gold is unique among all asset classes as it is much more of a hedging instrument rather than an investment instrument. We use it as a safe haven when holding asset classes such as equity and debt instruments, currency or even cash becomes too risky. It provides a good hedge against inflation as its price tends to increase with the rise in the cost of living. It is due to this inverse relationship with other asset classes that gold should be included in your portfolio to minimize the macro-economic and socio-political risks. During uncertain times, people with higher risk appetite can also use it as an investment instrument to fetch higher returns. Major global uncertainties like Brexit and elections in US, France and Germany can lead gold to fetch slightly higher returns than debt instruments. Thus, under current circumstances, hold 5–20% of your total portfolio in gold or gold-related instruments with an investment horizon of over 3 years. Types of gold-related instruments Once you have decided the share of gold in your portfolio, it is time to select the appropriate instrument. Physical gold: Till a few decades back, physical gold was the only way of investing in gold. However, holding physical gold has its own disadvantages. It requires a safe place for storage, such as a bank locker or your own household safe, which carries additional cost. Also, accessing your physical gold in your bank becomes a problem during natural disaster, political turmoil or normal holidays. The purity of physical gold can also be a major concern. Sovereign gold bonds: The Sovereign Gold Bond Scheme was launched by the Government in October 2015 to provide a superior alternative to holding physical gold. These bonds are issued by the RBI, which pays an interest of 2.75% per annum on the initial investment at every six months. These bonds eliminate the risks and costs of storage and purity-related concerns. The minimum and maximum investment per financial year is 1 gram and 500 grams, respectively. On the flipside, Sovereign gold bonds are low on liquidity and hence, it would be difficult for you to take the money out before five years. Gold ETFs: These funds invest in physical gold wherein investors are allocated units (that track gold price of one gram or half gram of physical gold) for their investments, which are then traded in stock exchanges. You need a demat account to hold your gold ETFs and a trading account with a brokerage house for buying and selling those units in stock exchanges. As these funds are passively managed, their prices closely track the price of physical gold. As investing in gold ETF is almost similar to investing in stocks, common retail investors face the same problems faced while investing in stocks. Timing the market becomes very important and additional costs like brokerage and annual charges are incurred for maintaining the demat account. The liquidity of gold ETFs might be an additional concern as the volumes of trades in gold ETFs are usually low. As a result, market prices of gold ETF often becomes lower than its own NAV. Gold fund of funds: These are open-ended funds that invest in gold ETFs. These are as liquid as normal mutual funds and can be bought and redeemed at NAV during business days. These also allow SIP mode of investment, thereby letting to you to average your investments and invest in small amounts. The taxation of gold funds is similar to that of physical gold and gold ETFs. Investments of over 3 years attract long-term capital gains tax while investments of up to 3 years attract short-term capital gains tax. How to choose between available optionsGold ETFs and gold funds score over physical gold in terms of security, liquidity and taxation. Among gold ETFs and gold funds, the latter scores higher because of being easily redeemable and allowing SIP mode of investment. The taxation of physical gold and gold-related instruments is similar. Thus, always opt for gold fund unless you buy gold specifically for personal consumption like marriages or gifts. Avoid gold ETFs unless you are comfortable with timing your investment.