Investing in a Gold Exchange Traded Fund (ETF) can give you better returns than investing in physical gold. Want to know how? Read on.
India is the second largest consumer of gold in the world, after China. India consumed an estimated 750 tonnes of gold in 2016. The frequent crashes in the stock market have made people even more interested in gold. Now that even Fixed Deposits aren’t giving great returns, many have started diversifying their portfolio by investing in gold.
What is Gold ETF?
Gold ETF is an ETF that tracks physical gold prices. The first gold ETF in India was launched by benchmark Mutual Fund in 2007. One unit of gold ETF is usually equal to a gram of gold. These ETFs are backed by physical gold of the highest purity. Gold ETFs were launched in India only a decade back. Unlike a Mutual Fund, an ETF will be listed on stock exchanges and are traded like stocks. Essentially, you will be buying gold in the electronic form through your demat account. Unlike physical gold where you need to pay wealth tax, there is no wealth tax for gold ETFs. Securities Transaction Tax (STT) also doesn’t apply. So, you can invest in gold without taking actual delivery of gold.
Using a gold ETF, you can easily invest in gold in small amounts at different price levels to ensure higher returns. Presently, there are 14 gold ETFs in India. While for some of them, one unit is equal to one gram of gold, for others, one unit is equal to half a gram of gold. For instance, if you invest in an ETF where 1 unit is equal to 1 gram of gold, the units will be allotted in such a way that the value of each unit you buy corresponds to one gram of gold. So, if you invest Rs. 27,000, when the price of 10 gram of gold is Rs. 30,000, you will be allotted nine units. You need to check the unit value before investing.
Additional Reading: 5 Golden Rules For Wealth Creation
How does it work?
Gold ETFs are funds that are managed passively and their returns will closely follow that of physical gold in the market. For redeeming your units, you can approach either the Mutual Fund house or the stock exchange.
Note that the Net Asset Value (NAV) of each of these funds will be different. Now, why is that?
The difference
Ideally, all gold ETFs where the unit of gold is the same should have the same NAV. However, NAVs do differ slightly. Why? This is because a gold ETF will not only buy gold it will also invest in some other assets like bonds and Government securities. Sometimes the ETF also holds cash in order to buy gold at lower prices. This is why the NAVs of different funds are different. Another point is the expenses incurred by the ETF. When the fund buys and sells gold on your behalf, they need to pay a number of charges such as brokerage fees, Value Added Tax (VAT), custodian charges, among others.
Depending on the accounting policies of the Mutual Fund house, the NAV of the fund will be adjusted for these expenses on a daily basis. Note that you pay fund management charges for investing in the fund. This is the reason why the NAV of the funds differs. For example, the NAV of Birla Sun Life Gold ETF stands at Rs. 2,783 while that of IDBI gold ETF is Rs. 2,790. Note that, usually, these differences in NAV are minimal if the funds have the same unit value. So, there won’t actually be much difference in the returns generated by them.
Additional Reading: All You Need To Know Before Investing In Gold ETFs
Check before investing
There are certain factors that you need to look at before you start investing in gold ETFs. Here’s the list.
Liquidity: You should be able to sell your ETF when you need money and quickly, right? Since gold ETFs are traded in stock exchanges, you need to understand how liquid they are. The higher the trading volume for the gold ETF, the more liquid they are. The more liquid the ETF, the easier it is for you to sell it.
Expenses: All Mutual Funds incur expenses and these expenses reduce your returns. So, the lower the expenses, the better it is. How do you know which fund incurs low expenses? Check its expense ratio. The lower the expense ratio, the better will be your returns.
Tracking Error: As you know now, gold ETFs track physical gold and for this, they use a benchmark. However, there usually is a slight difference between the returns that the benchmark generates and the fund’s returns. This is known as tracking error. The lower this error, the better because you want your fund to replicate gold prices as closely as possible. So, ideally, you should be going for funds with lower tracking error.
In Short
- Liquidity: higher trading volume = high liquidity.
- Expenses: Lower the expense ratio, higher will be your returns
- Tracking error: Lower the tracking error, the better the fund.
How to go about it
In order to invest in gold ETFs, you will need a demat account. If you already have an online trading account with any broker, you can buy gold ETFs yourself or by giving instructions to your broker.
- Open a demat account with a depository participant like National Securities Depositories Limited (NSDL) or Central Depository Services Limited (CDSL).
- Open an online trading account with your broker.
- Allocate money for the purchase.
- Choose the ETF that you want to invest it.
- Check its availability and price on the stock exchange.
- Place the buy order using the trading account or through your broker.
- Most Mutual Funds have a minimum investment criterion. Check before you invest.
- The units will be credited to your demat account. You can check the units credited and the amount at which they were purchased.
- You can redeem them anytime using your online trading account.
Additional Reading: Gold Vs Mutual Funds: The Big Fight
Want to invest without demat?
If you do not have a demat account but want to invest in gold ETFs, you can invest in gold Fund of Funds. These are Mutual Funds that invest in other gold Mutual Funds. However, these funds will have higher expenses when compared to gold ETFs because they will have their own fund expenses and they have to bear the expenses of Mutual Funds they invest in.
The biggest advantage with Fund of Funds is that you can invest through the Systematic Investment Plan (SIP) mode. Regular gold ETFs do not offer SIP. Investing through SIP will help average out your cost of investment. The minimum SIP amount for gold Fund of Funds ranges between Rs. 100 and Rs. 1000 per month, depending on the Mutual Fund house.
Additional Reading: Daily Vs Monthly SIP: Who’s The Winner?
What should you do?
Understand that gold ETFs score over physical gold on the returns aspect. However, when it comes to taxation, they are the same. If you hold either physical gold or gold ETF, you will pay short-term capital gains if held more than 3 years and long-term capital gains if you hold them for more than 3 years. You get indexation benefit for long-term capital gains. Whichever way you invest in gold, ensure that gold forms only about 10%-15% of your portfolio. Higher levels of exposure will reduce your portfolio returns. You must know that equities give the best return in the long term and you need to have more exposure to them when you are earning.
Sometimes you may find that gold prices have run up so much so that gold comprises over 15% of your portfolio. In this case, look at selling some of your gold holdings to reduce exposure to the precious metal.
Always remember that a well-balanced portfolio will give you the best returns. So, never invest in a single asset class. Always put your money in as many asset classes as possible. If one fails, others will make up for the loss.