Gold prices have gained over 17 percent in FY23, and around 8.2 per cent  year to date. Traditionally, gold has been regarded as a safe haven for investors, especially during financially turbulent markets. You can invest in gold in various forms: jewellery, gold bars, or coins if you want physical gold. Apart from that , you can invest in gold exchange-traded funds (gold ETFs), golf funds and sovereign gold bonds, owing to better returns and lower risk of storage and theft. 

Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth says it is always good to diversify 5-10 per cent of one’s portfolio in gold. 

Let’s explore the pros and cons of investing in digital gold to help you make the best decision:

Gold Exchange Traded Fund, or Gold ETF?

Gold exchange-traded funds are units representing physical gold in a paper or dematerialised form. One unit of a gold exchange-traded fund is represented by 1 gram of physical gold. It can be bought and sold at market prices.

Gold exchange-traded funds are stored in a Demat account without fear of it getting stolen and can be held as long as you want.

When you redeem a Gold ETF, you don’t get physical gold but receive the cash equivalent.

All the gains now will be classified as short term capital gains and taxation will be as per your applicable tax slab.

Gold exchange-traded funds have no securities transaction tax or GST, which are generally levied on physical gold purchases. 

You can use gold exchange-traded funds as collateral against loans. 

Unlike most other Mutual Fund schemes, Gold ETFs do not charge an exit load.

The difference between the two 

Risk: Sovereign gold bond is issued by the RBI and backed by the government, which makes it less risky. ETFs are backed by high-quality physical gold, but there are risks related to the AMC managing that ETF, explains  Vaibhav Khandelwal of Wint Wealth.

Liquidiy:  Gold ETFs are highly liquid as they can be traded on the stock exchange. Moreover, you can redeem them at any time. SGB cannot be redeemed before 5 years and it has low liquidity in the secondary market, making it a less liquid asset than gold ETFs.

Return: In Gold ETFs, only return is appreciation in gold pirce. In SGBs apart from gold price appreciation, an additional 2,5% interest is also available.

Expense: Gold ETFs are subject to asset management fees, which range between 0.2 and 0.5 per cent. Since SGBs are not managed by funds they do not incur any management charges or fee. Even gold mutual funds  charge an expense ratio, which covers the fund management fees, administrative costs and other expenses. Typically these funds charge an expense ratio between 1% and 2%.

Lock in: SGBs have an eight year lock in, ETFs and gold mutual funds have no lock ins. 

Taxation: For SGBs, your gains are exempted if held till maturity; if sold after 5 years  you will be taxed at 20% with indexation; sold within 1-5 years – 10%; sold before 1 year – at slab rate. For Gold ETFs, short-term gain taxable at the slab rate, long-term gain taxable at 20%. Taxation on gold mutual funds is similar to debt funds. From April 1, gains from investments in gold funds will be taxed at the slab rate irrespective of the holding period. However, you are liable to pay a 20.8% tax on long-term capital gains on gold sales.

How to purchase: SGBs can be bought online through the RBI’s website or through the websites of the participating banks and institutions. To invest in a gold ETF, you must have a demat account. Investors can buy and sell gold ETF units on stock exchanges.

“SGBs are issued by the RBI, while Gold Funds and Gold ETFs are managed by AMCs. SGBs offer a fixed interest rate, while Gold Funds and Gold ETFs track the price of gold. When it comes to risk, all three investment options are low risk. If you are looking for a safe and secure investment with guaranteed returns, then SGBs are a good option. However, if you need more liquidity and want to be able to sell your investment at any time, then gold ETFs are a better choice,” said Adhil Shetty, CEO of BankBazaar.

How to decide between SGB, gold fund, and gold ETF?

Investment Horizon 

For the long term, SGBs may be a good option as they offer a guaranteed return of 2.5% per year. SGB comes with a lock-in period of minimum 5-years. However, if you need access to your investment in the short term, then gold ETFs or gold funds may be a better choice, said Shetty. 

Risk Appetite   

SGBs are a safe investment and considered good for risk-averse investors, but they do not offer as much potential for capital growth as gold ETFs or gold funds. If you are looking for a more aggressive investment, then gold ETFs or gold funds may be a better option, he said. 

Investment Goals 

If you are investing in gold to protect your wealth against inflation, then SGBs may be a good option. However, if you are investing in gold to generate income, then gold ETFs or gold funds may be a better choice.

SGBs have three clear advantages over Gold funds/ETFs, according to Naveen Kukreja, Co-Founder & CEO, Paisabazaar 

1. interest income of 2.5% p.a. (in addition to the scope of capital appreciation) on the face value of the investment: : SGB offers an interest income of 2.5% p.a. to its investors on their nominal value of the investment, a feature not available in other gold-related instruments like Gold ETF or Gold funds. The accrued interest is credited to the investor on a half-yearly basis. However, the interest income is taxable as per the tax slab of the investor. 

2. Sovereign guarantee on interest income:  As the SGBs are issued by the Government of India, the interest income from SGB is covered by sovereign guarantee, the highest form of income protection available to any investors. However, the market risk of SGB is the same as gold ETF or gold funds as the capital gain/loss from SGB would primarily depend on the gold prices available during maturity or pre-mature redemption.

3. Tax treatment:  While the interest income received from SGB is taxed as per the income tax slab of the investors, the capital gains realised on holding SGB till its maturity is fully tax exempt. Being a listed bond, selling SGB before its maturity but after one year of holding would attract a long capital gains tax of 20% with indexation benefits. The capital gains realised on selling SGB within one year of investment would be taxed as per the tax slab of the investor. In case of Gold Funds/ETFs, the realised capital gains are taxed as per the tax slab of the investor irrespective of the holding period. Thus, SGB offers higher tax efficiency to the investors falling in higher tax slabs.

What should your gold investment strategy look like: 

Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth explains as follows:

 1. Physical vs Digital gold: Physical gold attracts 3% GST on the purchase, which is as good as a 3% capital loss. The price also may vary across sellers. Seller ‘A’ may sell at  Rs 40,000. But seller ‘B’ may sell at Rs 39,000. Thus, physical gold is only advisable if we need it for jewellery or other consumption. 

 2. Gold ETFs/ Mutual funds: Gold ETFs have no GST, and the price discovery is highly transparent. If an investor has a Demat, ETFs are better. If not, gold mutual funds are the way to go.

 3. Tax: All above are taxed similarly to debt funds. Only Sovereign Gold Bonds (SGBs) have different taxation.

Considering the pros and cons, if an investor is sure about gold investing for the long term, SGBs are the best way. Otherwise, Gold ETFs/ Gold mutual funds work better, said Kulkarni.

“Gold exchange-traded funds (ETFs) and Sovereign Gold Bonds (SGBs) follow the price of gold and are great alternatives to owning physical gold. The SGB option is better than the gold ETF option. It pays interest @ 2.5% p.a. for the entire term, and there are no taxes on capital gains at maturity. Gold ETF returns are treated as short-term capital gains and taxed at the applicable tax rate. In terms of liquidity, though, gold ETFs are better than SGBs because they are easy to sell on stock exchanges,” said Rahul Jain, President and Head, Nuvama Wealth.

Poonam Tandon, Chief Investment Officer at IndiaFirst Life Insurance believes investors should  buy gold on dips – there has been a slight correction in the price of gold currently and that can be used to accumulate the yellow metal.

Prashant K Goyal, Associate Professor – Finance JAGSoM believes gold occupy a serious space in one’s investment strategy at around 20% of one’s investible surplus. “I do not recommend physical gold for the purposes of investment. When it comes to non-physical modes of holding, safety-wise, I do not see much difference in a SGB or an ETF or a gold fund. However, my preference is for SGB as it comes with an additional 2.5% returns and, of course, guaranteed by the RBI,” he said. 

“SGB is an excellent avenue as it provides a coupon in addition to the prospects of price appreciation. Gold funds and ETFs are good for capturing the price upside for shorter horizons as it facilitates profit booking”, said Dr. Joseph Thomas, Head Of Research, Emkay Wealth Management.