Gold ETFs vs Sovereign Gold Bonds: Which is the better investment option

Gold ETF vs SGBs: Which is a Better Option?

It is said that investors must allocate 10% to 15% of their overall portfolio corpus to gold. Investing in gold can be done via gold bars, gold coins; but they can be quite cumbersome Two very popular ways of investing in gold as a financial asset is through gold ETFs (exchange traded funds) and via sovereign gold bonds (SGBs). It is tough to make an either / or choice since both gold ETFs and SGBs have their own merits and shortcomings. However, what is important to note is that both gold ETFs and SGBs are ways of holding gold in non-physical form. Non-physical gold overcomes problem like storage, transportation, insurance, safekeeping, conversion value depletion etc. How to choose between gold ETFs and SGBs?

Table of Contents

1. Gold ETF vs SGBs: Which is a Better Option?
2. Gold ETFs and SGBs are similar in some ways
3. How Gold ETFs differ from Sovereign Gold Bonds (SGBs)?

Gold ETFs and SGBs are similar in some ways

Interestingly, both SGBs and gold ETFs can be regarded as safe since they are regulated and backed by gold. The difference is that in the case of SGB, there is an explicit guarantee by the government on gold value in grams and the interest payment. But there are also other ways in which gold ETFs and SGBs are similar. Both gold ETGs and SGBs are in non-physical form and that substantially reduces the cost of holding gold. Storage and administration costs are also low since these gold ETFs and SGBs can be purchased in the secondary market with minimal entry and exit costs. The third similarity is that both are backed by physical gold while 1 is actually backed by gold in a custodian bank, SGBs carry a central guarantee.

How Gold ETFs differ from Sovereign Gold Bonds (SGBs)?

Before you make a choice between SGBs and gold ETFs, here are some key differences to know about.

• In terms of returns, SGBs have an edge over gold ETFs since the SGBs pay 2.5% (subject to change from time to time) assured interest per annum. Other than that, both are a play on the price of gold, so the market risk is always there that gold price could fall down. Gold ETFs entail transaction and statutory charges, apart from the total expense ratio (TER) of the fund that gets debited to the unit holder.
• Secondly, gold ETFs are not accepted as collateral by most banks for loans. On the other hand, getting loans against gold bonds is a lot easier and the bank through which you buy the gold bonds arranges the loan.
• SGBs score on capital gains taxation. Gold ETFs are treated as non-equity so they become long-term gains if held for more than 3 years. LTCG is taxed at 20% with an indexation benefit while STCG is taxed at the peak rate applicable. In the case of SGBs, the entire capital gains amount is tax-free in the hands of the investor if it is held for the full quota of 7 years.
• One area where gold ETFs score over SGB is in secondary market liquidity. Entry and exit from gold ETFs is quite simple. Gold ETFs can be bought and sold in the secondary market like any other stock and follow the normal T+2 rolling settlement cycle. On the other gold bonds are not available on tap, but only with the government issuing the tranche. The secondary market liquidity in SGBs is very thin.
• The other area where gold ETFs score is in the ability to manage risk. You can put stop losses and exit gold ETF if the pricing is not to your liking. That flexibility is not available in SGBs. Also, there are no upper limits to the transactions in gold ETFs while gold bonds cannot exceed 4KG per year.

The choice between gold ETF and SGB has to be made based on overall returns, risk, tax efficiency, liquidity and simplicity. While SGBs score on returns, risk and tax efficiency, it is gold ETF that score on availability and liquidity. The choice is yours!