Investing in Gold the ETF Way
Introduction
Arjun is a worried father these days. His daughter's wedding is planned in the next 6 months. Over the last 2 years or so gold prices have soared from near about Rs 10,000 per 10 grams levels to Rs 17000+ levels. This frenetic rise in the prices of gold and that too in such a short period of time will leave any father worried whose daughter's marriage is round the corner.
Gold as an Investment Asset Class
If you observe the way gold prices have behaved in the past decade you will be surprised. At the beginning of the decade in 2001 gold prices were hovering around Rs 4100 per 10 grams. Today as we near the end of the decade, gold prices stand at Rs 17,000 per 10 grams. This effectively means that in the last 9 years gold prices have more than quadrupled (multiplied more than 4 times). Had somebody invested in gold at the beginning of the decade by now he would have earned a handsome yearly return of 24-26%. This is much better than the returns given by PPF, NSC, Bank FD's and other Fixed Income Securities (Debt Instruments). These high returns make a very strong case for gold as a good long term investment. Gold can be looked as an investment for long term wealth creation. Also in 2009 the price of gold increased by Rs 3,500 as compared to a year earlier from around Rs 13,500 and closed the year at around Rs 17,000 giving an annual return of 26% in 2009. As the demand-supply situation remains tight the prices are expected to rise further. We Indians are very fond of gold and hence India is one of the largest consumers of gold in the world.
Accumulating Gold for Children's Wedding
In a common Indian wedding any family buys 25-30 tolas (250 – 300 grams) of gold. If someone would have bought this quantity of gold at the beginning of the decade in 2001 it would have cost him Rs 1.2 lakh (300 grams @ Rs 4000 per 10 grams). But the same quantity of gold as on today will cost Rs 5.1 lakhs (300 grams @ Rs 17000 per 10 grams). To bear such a huge bill only for gold is bound to burn a big hole in any father's pocket. If Rs 5 lakhs is spent only on gold how will the family manage the other expenses related to the marriage???????? Many parents will face this situation in future the way gold prices are soaring and making new highs with every passing day.
Even after reaching these levels the price of gold shows no signs of relenting or stopping due to the tight demand-supply situation and international events which are beyond the control of the common man. From hereon where will gold prices head in the next 5-10 years no one knows? But like this decade, in the next decade also if prices of gold quadruple from today's levels it will surely leave many more fathers like Arjun fuming. We are not trying to predict the direction of gold prices in the next 5-10 years. Nor are we trying to scare you. Relax ……….. we are just trying to make you better prepared as a parent in case such an eventuality happens.
Little bit of smart planning can help you reach your target of 25-30 tolas of gold for your children's wedding; irrespective of the gold prices; by the time your children reach the age of marriage. Interested in knowing how???? Gold ETF (Exchange Traded Fund) is the simple answer. Through this product you can accumulate as little as 1 gram of gold every month.
Let us come back to Arjun's case. Had he started accumulating 1 gram of gold every month through a gold ETF mutual fund since the time his daughter was born, it would have taken him 300 months to reach his target of 300 grams of gold. Now 300 months translated into years comes to 25 years. This effectively means that by the time Arjun's daughter reaches the marriage age (average marriage age is 25 years) he is ready with the gold required for her marriage. At today's prices, 1 gram of gold will cost Arjun a monthly investment of Rs 1700 which is within the reach of common man.
Does reaching the gold target before time or by the time your daughter reaches marriage age, sound heartening? Interested in knowing more about gold ETF's?
………… read on. Yes, with gold ETF's you can accumulate as low as 1 gram of gold every month in electronic format in your demat account just like equity shares without having to worry about safety aspect (where to keep physical gold safely) and without worrying about the quality of gold and other many other features. That's the beauty of this product. So let's explore this product.
Gold Exchange Traded Funds (ETF)
Gold ETF units are just like units of a mutual fund. They are listed on the stock exchange and traded just like equity shares. Units of Gold ETF can be bought and sold just like how units of equity shares can be bought and sold through a stock exchange. Just like a single unit in shares represents 1 equity share; similarly in gold ETF's one unit represents one gram of gold. At the current prices of gold at Rs 17,000 one gold ETF unit (1 gram) will entail an investment of Rs 1700. While the minimum quantity that can be bought and sold is one unit (1 gram); the maximum number of units that can be traded depends on the paying capacity of the person.
Buying of gold ETF units gives the person exposure to pure gold. All the units of gold ETF mutual fund that are traded on the stock exchange are backed by purchase of physical gold by the mutual fund that has launched the ETF. The gold ETF mutual fund invests in standard gold bullion (99.5% purity). The price of a unit of gold ETF tracks the price of gold in the international market. By holding the gold ETF units in his demat account, the investor can benefit from the rise in the price of gold. As the price of gold rises in the international market the value of the gold ETF units also increases. The investor can later sell the units very easily at a higher price than what he bought them for, just like selling shares and book profits. So the price of a unit of gold ETF moves in the same direction as the price of gold in the international market.
Demat Trading of Gold ETF Units
Since gold ETF's are bought and sold through a stock exchange; dealing in gold ETF's requires a demat account. If a person already has a demat account for equity share trading then he can use the same demat account for buying of gold ETF units. A person who does not have a demat account, first needs to open a demat account before he can start buying gold ETF's. A demat account can be opened through any of the stock brokers by submitting a duly filled account opening application form along with KYC (Know Your Customer) documents as per SEBI guidelines.
Once the demat account is opened a person can start accumulating gold ETF units on a monthly basis or as per his / her convenience. For every order the minimum quantity is one unit (representing one gram) and maximum depends on the paying capacity of the person. Since the delivery of gold ETF units is taken in the demat account (Electronic format), the investor is saved from the hassle of taking physical delivery of gold.
Physical Gold Buying V/s Gold ETF
Since years people have been buying gold the traditional way in the form of jewellery or gold biscuits and coins. Then the natural question that will come to ones mind will be why should I buy gold through gold ETF units in demat (electronic) format. Taking the delivery of gold ETF units in demat format over physical gold comes with its own advantages like:
- In case of gold ETF's the person need not worry about the purity and quality of the gold. This aspect is taken care of by the stock exchange and the other regulators. There is no impurity risk of any sort in buying gold ETF's. The gold ETF mutual fund invests in standard gold bullion (99.5% purity).
- Since the investor is not taking physical delivery he need not worry about storing physical gold at a safe place. Imagine that if you go on accumulating one gram of physical gold every month; after 16 years you will have almost 200 grams of physical gold to take care of. If you keep this gold at home, it's bound to give you sleepless nights. But since in gold ETF's the physical delivery aspect is taken care of; you can enjoy sound sleep at night and leave the worry of guarding your gold to the mutual fund AMC.
- Also you need not spend money on gold insurance and bank locker rent as there is no physical delivery of gold involved.
- You can buy gold ETF units at the market price. Normally if you buy gold coins or biscuits from banks or jewellers; their prices are different from each other. Also some banks normally charge a premium of 3-5% over the market price of gold. So the gold ETF pricing is very transparent.
- Similarly when you sell gold ETF units you can sell them at the current market price. There are no cutting charges or making charges or there is no discount to market price at the time of selling the gold ETF units. This ensures that you get a fair price for your gold at the time of selling. Also there are ready buyers available through the exchange for your gold at any given point of time. So this ensures adequate liquidity and you can sell your gold ETF units at any point of time without any loss of value or very little loss of value. Banks normally don't buy back gold sold by them. Jewellers do buy back gold but at a discount to the market price.
- With gold ETF's at a time you can buy as low as 1 gram of gold or half a gram of gold at a time. If you buy gold in the form of coins or biscuits you may have to buy a minimum of 5 grams of gold at a time. Buying half a gram of gold through gold ETF every month is within the reach of common man; but buying 5 grams of physical gold every month may not be within the reach of everyone. So the low entry point offered by gold ETF's is definitely an advantage as compared to physical gold.
- If the value of your physical gold goes above a certain level (presently Rs 15 lakhs) then you are liable to pay wealth tax. But investing in gold through gold ETF's does not attract any wealth tax.
- If you buy physical gold and hold it for less than 36 months and sell it; you are liable to pay short term capital gains tax. But in case of gold ETF's if the person holds the gold ETF units for more than 12 months then he has to pay long term capital gains tax. So from tax point of view also gold ETF's have an edge over physical gold.
So you see buying gold through gold ETF's rather than traditional ways (jewellery or gold coins and biscuits) has lot of advantages.
The ETF holder (investor) just has to pay an annual expense of the scheme which is also known as fund management charges. This charge is in the range of 0.5% to 1.5% per annum.
Companies offering Gold ETF's in India
So after reading the advantages of investing in gold through gold ETF's over traditional ways, if you are convinced the next question that will come to your mind is from where can I buy gold ETF's? Presently there are 5 companies that offer gold ETF's. These are as follows
- UTI Gold ETF – GOLDSHARE
- Benchmark Gold ETF – GOLDBEES
- Reliance Gold ETF – RELGOLD
- Kotak Gold ETF – KOTAKGOLD
- Quantum Gold ETF (one unit is half gram) – QGOLDHALF
Apart from Quantum Gold ETF in case of all the other four gold ETF's one unit is equivalent to 1 gram of gold. All the 5 gold ETF funds are listed on the stock exchange. The units of any of these gold ETF's can be bought through a stock broker. Gold ETF's are very popular in the international market. SPDR Gold ETF is the world's largest gold ETF. Another example of international gold ETF is iShares Comex Gold Trust.
Taxation of Gold ETF's
Gold ETF's are treated as non-equity mutual funds. The taxation of returns depends on the holding period of the gold ETF units. If the gold ETF units are held for less than 12 months then the gains are taxed as short term capital gains. So in this case the returns are clubbed in the overall income of the person and depending on which tax slab he falls in; he will be taxed accordingly.
If the holding period of the gold ETF units is more than 12 months; then the profit made by selling the gold is classified as long term capital gain. Here the customer has to pay either 10% on the gain (profit) without indexation. Or the tax on the profit is 20% with indexation which ever is lower.
In case of physical gold (coins and biscuits) they are required to be held for 3 years or more to be classified as long term capital gains. If sold before 36 months then short term capital gains tax will have to be paid. So investing in gold through gold ETF's has tax advantages over investing in physical gold.
Conclusion
We have seen how gold can be accumulated through gold ETF units for long term wealth creation or for financial goals like accumulation gold for daughter's wedding. Even today maximum people in India buy gold the traditional way in the form of jewellery or pure gold. Gold ETFs and Gold Futures are a recent phenomenon although they are fast catching up as the awareness of these products increases among the masses.
Fathers like Arjun which we saw at the beginning of the article, can accumulate gold through gold ETF units over a period of time for their daughter's wedding or son's wedding by investing some amount on a monthly basis in a gold ETF fund. He can keep accumulating one gold ETF unit (1 gram) every month regularly from the time the daughter/son is born. His purchase costs will get averaged out over a period of time. Through gold ETFs a person can accumulate as little as half a gram or one gram of gold every month. By the time the child reaches marriage age in 25 years i.e. in 300 months the father would have accumulated 300 grams of gold. And finally when the marriage event happens just before that the father can sell all the gold ETF units at one go and buy physical gold or jewellery in bulk from the market for the marriage. So in this way a little bit of smart planning can save the father from the last minute rush for buying gold for the child's marriage at exorbitant prices which can burn a big hole in his pocket. At the same time the father can realize the dream of having a Lavish Big Fat Indian Wedding for the son/daughter.
To conclude, whatever be the reason for buying gold and in whatever form, it should form 10-20% of a person's investment portfolio be it in the form of jewellery, biscuits, bars, coins, ETF units etc after all we Indians love our gold; don't we????
