We recognise that many of you may be rushing to your nearest jeweller to buy physical gold in the form of gold coins, bars or jewellery on the auspicious occasion of Akshaya Tritiya; but hold on. Are you making a right investment decision by investing in gold in physical form? Do you know the perils of buying and holding physical gold? While many of you may be shocked, but yes indeed there are perils of holding gold in physical form.

You see, we recognise that many of you prefer to hold in physical form as you get to touch, feel and see your gold holdings – and feel contended about it; but let us apprise you that there are major demerits of buying and holding gold in a physical form. They are:
 

• Holding cost: Holding gold in a physical form comes at a “holding cost”. Holding cost refers to the cost of holding a security. Hence, the locker rent which you pay for stacking your gold in the bank locker (in order to protect it from theft or burglary) constitutes to be your holding cost.
   
• Quality: Unless the gold which you buy is from a reliable source, the quality of the same is always under question, thus resulting in your precious asset losing its true value. Thus, say if you buy a certain amount of gold from your jeweller and sell the same piece of gold (either coins or bars or jewellery) to another jeweller, then the quality of your gold will always be questioned.
   
• Premium: Very often jewellers and banks sell gold coins and bars at a premium, to the market price. This premium is usually in the range of 5% - 10% (inclusive of making charges) in case of jewellers and upto 15% in case of banks. So, in that sense the pricing of gold varies depending on the vendor. Thus, ultimately you always pay a higher price to acquire your gold in the physical form.
   
• Resale Value: While selling your physical gold, you must have encountered some horrendous experiences of your gold merchant telling you “this is not 100% pure – it has some mixing”, thus questioning the quality of the gold held by you. Moreover, even if the quality of the gold held by you is of the finest purity, the making charges will be deducted while converting your gold into jewellery. And as regards the banks are concerned, they will refuse to buy-back your gold (as they are not allowed to do so as per RBI regulation).
   
• Tax: If you are a gold bug, then you would also be axed by wealth tax on the value of physical gold held by you. Moreover, in order to be eligible for long term capital gains, you need to hold your physical gold for more than 3 years. Thus, if you were to sell your gold holdings within 3 years for any reason whatsoever you would be liable to capital gains tax based on your marginal rate of taxation.
   

Hence given the aforementioned demerits of investing in physical gold, PersonalFN recommends that you become a smarter investor and prefer Gold Exchange Traded Funds (ETFs) for the host of advantages which they offer. But before that, first let’s understand the meaning of gold ETFs and to do so prima facie understand what is meant by ETFs. ETFs are instrument, offered by mutual fund houses and are listed on a stock exchange. They represent ownership in an underlying security, commodity or asset. Hence, now to put it simply, a Gold ETF is an instrument that represents an ownership of gold assets. This gold is held on your behalf by an appointed custodian for the ETF.

When you buy a Gold ETF, you get a contract indicating your ownership in gold equivalent to the rupee amount of your investment. They are a kind of open-ended funds which track prices of gold, and each unit of gold in the fund that you can buy, is equivalent to 1 gram of gold (some fund houses also offer 1 unit at 0.5 gram of gold). However, the drawback here is, you will never get to see the gold you own – you will only have a contract that represents your ownership interest. However, you may be allowed to convert your paper gold into a physical gold, only when you have gold units equivalent to 1 Kg. Since, Gold ETFs are listed and traded on a stock exchange you can transact (i.e. buy and sell) in them on a real-time basis. But to own them you need to open a demat account along with a share trading account with a broker. While transacting in Gold ETFs, you would be required to simply call your broker and place your orders (at the prevailing market price), or do the same with the online trading application provided by your broker.

And now, speaking about the advantages of buying and holding gold ETF, they are as under:
 

• Convenience: Gold ETFs are a convenient means of investing in gold because there’s no question of physical delivery. Hence, you do not have to worry about the storage and security aspects that are typically associated with investing in physical gold.
   
• Quality: The biggest advantage of buying and holding gold ETFs is that, you don’t have to worry about the quality of the gold which you hold; because as per the Securities and Exchange Board of India (SEBI) regulations, the purity of underlying gold in gold ETFs should be 0.995 fineness and above.
   
• Low cost: The only cost which you will be incurring here is the cost of maintaining a demat account and trading account with a broker, and the nominal brokerage for each transaction. Finally, there are annual recurring charges which are charged to the fund. Hence the locker rent, which is rather substantial part of the holding cost, is done away with.
   
• Premium: Unlike physical gold buying where many of you may have encountered the horrendous experience of the gold vendor charging a premium; transacting in gold ETFs is at the prevailing market rate. Thus there is no question of you shelling out more to fill the pockets of anyone who is selling gold – be it a gold merchant or banks.
   
• Resale value: Unlike physical gold, gold ETFs can be easily sold in the secondary market on a real-time basis (i.e. at the prevailing market price). So any number of units held by you in a Gold ETF can simply be sold (subject to the existing units held by you) in the secondary market on a real-time basis at the prevailing market price at any time during the trading hours of the exchange. Thus, this precludes you from encountering horrendous experiences, which you otherwise face while selling physical gold (where the jeweller doubts the quality of gold held by you - and therefore pays you a less price, while in case of jewellery, deducts making charges which are added while buying gold). And as regards banks are concerned, they refuse to buy back gold (due to RBI regulation).
   
• Taxation: Tax implications on Gold ETFs are same as those on debt mutual funds. A unit of a Gold ETF that is held for less than twelve months is treated as a short-term capital asset. Gains on the same are taxed at your marginal rate of tax (i.e. as per your income slab). Units held by you for more than twelve months are treated as long-term capital assets, and would be subject to long-term capital gains tax at 20% (after allowing for indexation benefit) or 10% (without indexation benefit), whichever is less.
   

Moreover, you do not have to worry about Wealth Tax if you invest in gold ETF.

What to look into while investing in gold ETFs?

For those of you who are convinced about investing in gold ETFs and are willing to forgo onto the “touch, feel and see” factor as available in investing and hold physical gold, here’s what you need to consider while investing in gold ETFs:
 

• Percentage of holding in physical gold: Ideally, one must select a gold ETF that holds a significant portion of its portfolio in gold over ones that take cash calls i.e. invests in current assets; the impact of this on performance can also be disclosed through the tracking error of the gold ETF.
   
• Expense Ratio: One must also look at the expense ratio while selecting gold ETF. This is because gold ETF with a lower expense ratio would translate into higher returns.
   

Those of you may who may be disappointed over having to open an demat account to invest in gold ETFs or do not have one and / or neither want to open one, but still want to invest in gold ETFs, then a relatively a new investment avenue known as Gold Savings Funds are available. Gold saving funds (also known as “gold funds”), is another relatively new breed of unconventional way to invest in gold. Gold Saving funds are generally fund of fund schemes which invests their corpus into an underlying Gold ETF which benchmark their performance against the physical prices of gold. Hence by doing so, they attempt to provide returns that closely correspond to the returns of its underlying Gold ETFs. But here, unlike Gold ETFs (where you hold units in your demat account); in gold funds you are allotted with units of the fund in a paper form (it reflects in the mutual fund account statement); so it does not make it mandatory for you to have a demat account. Moreover, gold funds apart from lump sum investing, offer the Systematic Investment Plan (SIP) mode, which is effective and convenient way of investing regularly in gold. However, while investing in them one may have to bear a slightly high expense ratio due to its nature of being a fund of fund scheme.

To conclude, while many of us buy and hold gold for both emotional and financial reasons, it is imperative to weigh the pros and cons of investing in the conventional way of investing in gold (i.e. physical form) and unconventional form (i.e. through gold ETFs and / or gold savings funds) and take prudent investment decision.

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smithgeorge836@gmail.com Sep 02, 2014 Today most IRA accounts invest in low-interest ventures and for that reason they don’t generate much return other than what you put in the account. Your blog is very informative. I agree with you that gold investment is the best investment because its value increases over time. Gold investment is very useful for your life after retirement, if you invest in self-directed IRA accounts. Gold prices jumped about 20% in the festival season and great amount of coins and bricks purchased by many people.

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