InvestorQ : As an investor how good is sovereign gold bonds (SGBs) as an investment class and are the returns on these bonds justifying the risk?
Mary Joseph made post

As an investor how good is sovereign gold bonds (SGBs) as an investment class and are the returns on these bonds justifying the risk?

sara Kunju answered.
2 years ago

Sovereign gold bonds have been around for some four years now and they have attracted a good amount of buying interest from HNIs and also from retail investors. Since late 2015, Sovereign Gold Bonds (SGB) guaranteed by the government of India has emerged as a veritable investment options for individual investors. The idea of the Gold Bonds was to help investors participate in the movement of gold prices without going through the hassles of buying and selling physical gold. Sovereign gold bonds have some distinct features which are not available in other forms of gold investments. Let us look at some of the unique characteristics of gold bonds as an investment class.

Gold bonds can be one of the most cost effective forms of holding gold

Compared to holding physical gold, it makes a lot more prudent sense to hold gold in the form of sovereign bonds. When you buy and sell jewellery, there is a loss of 15-20% in making charges each time you change the form of gold. You can also hold gold in the form of gold bars or gold coins. But, physical gold has a cost in terms of storage, insurance, safety etc. SGBs can be held either in the form of physical certificates or even in your demat account. The hassles of maintenance of gold and loss in translation are largely avoided in SGBs. This is a major advantage of gold bonds.

One can argue that gold ETFs can also be held in demat form but then there is a cost aspect to gold ETFs. You normally buy gold ETFs at the prevailing unit price of gold units but there is a transaction cost each time you enter and exit. Additionally, the annual AMC cost of 1% also gets debited to the NAV of your gold ETF. SGBs, on the other hand, have no such costs loaded on to them. On the contrary, these gold bonds are normally issued by the government at a discount to the average market price, offering an added advantage. This often proves to be the major advantage of gold bonds as a form of holding on to gold.

The 2.5% interest paid on gold bonds can be a game changer

There is no other form of gold investment that pays you interest on the amount invested. This is special in case of gold bonds because the benefit of interest is over and above the price appreciation that you anyways get on these gold bonds. This is a fairly important point from the investor’s point of view. Whether you hold gold in physical form or in ETF form, there is no regular assured income that you receive. You only gain if the market price of gold moves up. The SGB, on the other hand, pays an annual interest of 2.50% to investors. This is down from 2.75% interest paid earlier, but that is still a good way to put your idle gold investments to use. At least you get partially compensated for the inflation risk annually. In the meantime, if the gold prices go up, then you anyway stand to gain from the price appreciation. These bonds are also free from default risk as the interest payments and the principal redemption are guaranteed by the government of India. This makes these gold bonds almost risk free from the point of view of the investor and the government guarantee makes it a lot safer as an investment class.

In taxation terms, gold bonds can be more efficient and enhance post tax returns

Post tax returns matter in the ultimate analysis and that is where these gold bonds actually score. One important thing to remember about Sovereign Gold Bonds is that they are relative more tax efficient compared to physical gold. Let us understand the capital gains tax aspect of SGBs. Gold is treated as a non-financial asset and hence the definition of capital gains is a holding period of 3 years in case of gold. If you sell you gold within a period of 3 years then you are liable to pay short term capital gains tax at the peak rate that is applicable to you. If you sell gold after a period of 3 years, then it is classified as long-term capital gains. It will either be taxed at a rate of 10% without the benefit of indexation or at 20% with the benefit of indexation. In case of SGBs, redemption of gold bonds will be entirely tax free in the hands of the investor. (Gold bonds have tenure of 8 years and can be redeemed after a period of 5 years). However, if the SBGs are sold in the secondary market then they will attract capital gains at the extant rates. Interest on SGBs is taxable like normal interest receipts at your applicable tax rate. Keep that in mind when you are exiting gold bonds in the secondary market because that is taxable at your peak rates. That could substantially reduce your effective returns in post tax terms.