Gold traditionally holds tremendous cultural importance in India, especially during weddings, pujas, and other festivities. Dhanteras, which falls two days before Diwali, is considered one of the most auspicious days to buy the yellow metal, and it’s no surprise that it’s the biggest gold buying day in India.
Some people buy gold to wear in the form of jewellery while others buy it as an investment to generate returns and diversify their portfolio. Even for many of those who buy jewellery, investment is usually the motivation.
While we have maintained the tradition of gold buying, it has come at a huge cost. Most people would have earned a decent return on their gold investments if they had been augmented with the right choices.
With advances in financial markets and technological innovations, we have witnessed new products offering exposure to gold, but our habits haven’t kept pace. Therefore, to make a smart investment choice this Diwali, I believe it is important for all of us to understand what the different investment avenues are, and which of them can provide the maximum returns.
Jewellery is not a smart investment
Earlier, the only form of gold that people preferred to buy was jewellery, partly because it was the only form of purchase legally allowed in India. As much as it was an ornament to wear, it was also a quasi-investment. It was also a security against any cash crunch, where people could deposit the jewellery with a moneylender and obtain a loan against it. However, times have changed and people have realised that jewellery is no longer an efficient investment choice.
When an investor buys jewellery, there are many upfront charges that eat into returns and defeat the purpose of an investment. With 3% GST levied on the value of the product and high making charges of about 10-15%, the investor loses close to 18% the moment the product is bought.
Additionally, while selling the product, the price is usually 5-8% lower than the purchase price, resulting in a further depreciation in investment value.
Similarly, with bars and coins, although the making charges are low (about 2-3%), there is still a loss of around 5-6% up front (including GST paid) and the wide buy-sell spread makes it an equally inefficient choice.
Other investment options
A few years ago, fintech companies launched Digital Gold, which is hassle-free compared to buying physical jewellery. Here, the consumer buys gold online and the equivalent amount of gold is stored in vaults by provider companies. The primary features are: the gold can be bought or sold 24/7 at the click of a button. The companies accept lower denominations, as low as Re 1, and take care of storage and insurance.
Although these features are exciting, they come with a cost. The price is usually 2-4% higher than the market price, GST paid is lost after the purchase and they have wide buy-sell spreads. All of this punches a hole of about 5-10% into investor returns the moment we buy digital gold. In addition to not being price efficient, digital gold is also unregulated.
Let us look at other paper products that are available in the market. The Reserve Bank of India has started issuing Sovereign Gold Bonds since 2015. These bonds are not backed by any physical gold but come with a sovereign guarantee and have an eight-year maturity that can be redeemed only after five years. Each bond is equivalent to 1GM gold and is sold at the market price. These bonds provide an additional 2.5% return every year until maturity and capital gains on maturity are tax free. The only drawback with this product is that if the investor wishes to sell it before the redemption window opens, he can do so only on the exchanges. However, with the lack of liquidity in the secondary market, bonds are traded at a discount to the market price, causing a loss to the investor.
Gold ETFs and Gold Mutual Funds: The intelligent choice
Gold ETFs are exchange traded funds backed by physical gold. Each ETF unit of gold is backed by 24-carat gold, which is stored in secure vaults and comes with comprehensive insurance.
Many ETFs provide investors the option to invest at low denominations of 0.01 grams at wholesale prices, making it affordable and cost-effective. Buy-sell spreads are tight with prices trading near market levels.
The ETF unit price moves in tandem with gold prices with a minimal tracking error. Moreover, an expense ratio of less than 1% and benefit of GST credit that ETFs get as passthrough vehicles makes the product even more price efficient.
All this makes Gold ETFs one of the best choices for gold investment compared to other available products. Therefore, this Diwali, if you wish to invest in gold, you can look at buying gold ETF units, the way stocks are purchased, and make an intelligent choice.
If you do not have a Demat account and want to invest a lumpsum amount as in a mutual fund, Gold Fund of Funds that invest in gold ETFs, popularly known as Gold Savings Funds, can also be a good choice.With a significant correction in gold prices from the peak and ongoing geopolitical and macroeconomic uncertainties, this is an opportune time to add gold to the portfolio. We recommend a 15-20% exposure to gold to boost your portfolio during market drawdowns and enhance returns.