Sovereign Gold Bond Scheme has been launched. Given the penchant we have for gold, I have seen a lot of curiosity around the Sovereign Gold Scheme. The major attraction under the scheme is the interest of 2.75% p.a. No other form of gold investment (physical gold, Gold ETFs, Gold Mutual Funds and gold jewellery) offers this kind of regular income. In this post, I will discuss the scheme in detail and various pros and cons of the scheme. Finally, I will discuss how it fares against other forms of gold investment.
How the Sovereign Gold Bond Scheme works?
The mechanism is simple.
- Instead of purchasing physical gold, you purchase equivalent number of gold bonds. Each bond unit is equivalent to 1 gm of gold. For example, purchase 50 units of gold bonds instead of 50 gms of gold.
- You get interest on the total purchase amount.
- At the maturity, you get the price of 50 gms of gold.
Other Salient Features
The Sovereign gold bond is denominated in multiples of grams of gold with a basic unit of 1 gm. You can purchase in multiples of 1 gm. You can purchase a minimum of 2 1 gm (1 unit) and a maximum of 500 gms (500 units) of Gold bonds every financial year.
Issue price for this tranche of bonds is Rs 2,684. This is the simple average of price of gold of 999 purity for the previous week (October 26-October 30) as published by Indian Bullion and Jewellers Association.
Fifth tranche of gold bonds is open from September 1, 2016 till September 9, 2016. The issue price for the latest tranche is Rs 3,150 per gram. It is the simple average of price of gold for the previous week (August 22-August 30) as published by Indian Bullion and Jewellers association (IBJA).
The rate of interest for these bonds is 2.75% p.a. The interest shall be paid every six months. So, for an investment of Rs 1 lacs, you will get Rs.1,375 every six months.
How can I invest in Sovereign Gold Bonds?
Bonds will be sold through banks and designated post offices.
The bonds are available in both paper and demat format. These bonds will be listed on exchanges.
A few investment portals such as ICICIDirect also permit online investment in Sovereign Gold Bonds.
Who can invest in Sovereign Gold Bonds?
Only residents can invest. Non-resident Indians (NRIs) cannot invest in these bonds. HUFs and trust can also invest.
What is the maturity of Sovereign Gold Bonds?
The bonds will mature in 8 years. However, the investors have an option to exit after the 5th year. This option of premature exit can be exercised on interest payment dates. This means, after 5 years, you will have an option to sell it back to the Government.
Bonds will be redeemed in cash on date of maturity at the prevailing price of gold. Please note you will not get physical gold at the time of redemption. You can use the redemption amount to purchase gold in the market though.
The redemption price shall be the average closing price of gold of 999 purity during the week prior to redemption (as published by IBJA).
You can exit before 5 years too. The sovereign bonds will also be listed on stock exchanges. So, theoretically, you have an option to exit before 5 years too. It remains to be seen if there will be enough liquidity in the secondary market for these bonds.
The first three tranches of Sovereign Gold Bonds have already been listed on stock exchanges. However, the liquidity is quite low.
Is there any risk?
The bonds are issued by Reserve Bank of India on behalf of the Government of India. Therefore, these bonds carry sovereign guarantee. There is no risk of default.
The redemption value of these bonds is linked to the price of gold. Hence, there is price risk. You would have borne the same risk if you had purchased physical gold.
If at the time of redemption, value of gold is lower than your purchase price (of Rs 2,684 Rs 3,150 in this tranche), you will suffer capital loss. For instance, if at the time of redemption, the prevailing price of gold is Rs 3,000 per gm, then you will get only Rs 1.5 lacs back (for 50 gms). Remember you had invested Rs 1.57 lacs in the first place.
However, if gold prices go up, you will get the dual benefit of interest and capital appreciation. Suppose if the gold price has moved to Rs 3,500 per gm by the time you redeem, you will get back Rs 1.75 lacs.
What about the taxation of such bonds?
Interest will be taxed at your marginal tax rate i.e. it will be added to your income and taxed as per your income tax slab.
Tax treatment of capital gains will be same as that for physical gold. If you hold these bonds for less than 3 years, capital gains, if any, will be taxed at your marginal income tax rate. For more than 3 years, capital gains will be taxed at 20% less indexation.
You can purchase physical gold today and hold it for 50 years. However, gold bonds need to be mandatorily redeemed after 8 years. Normally, this redemption would have given rise to capital gains tax implications. This would have been a great disadvantage for gold bonds.
To take care of this issue, the Government in Union Budget 2016 clarified that redemption of gold bonds will not give rise to capital gains tax liability(by amending Section 47).
There is no capital gains tax liability if you redeem these bonds (sell it back to the Government).
Do note this benefit is only for redemption.
If you sell in the secondary market, be prepared to pay capital gains tax (if there is gain).
If you sell within 3 years, capital gains will be taxed at marginal income tax rate.
If you sell after 3 years, capital gains will be taxed at 20% after indexation.
TDS is not applicable at the time of redemption of these sovereign gold bonds.
Good Points
- You get 2.75% p.a. rate of interest which is not there with any other form of gold. You don’t get interest income under any form of gold investment or purchase.
- Like physical gold, you will be able to take loans against these sovereign gold bonds too. The option must be used only in case of an emergency. The rate of interest on the sovereign bold will reduce the total interest burden of such loans. However, if you are already thinking about loan against these gold bonds, you shouldn’t be investing in these gold bonds in the first place. Personally, I would rather sell gold and get funds than take loan against it.
- If you purchase in demat format, you do not need to worry about theft. Even physical gold is not much of a concern; you can simply take a locker in a bank.
- Partial premature withdrawals are allowed in multiples of 1gm. This can happen only after 5 years.
Drawbacks
- You may find it difficult to exit at a favourable price in the secondary market. The liquidity for the first three tranches is quite low.
Your money will be virtually locked-in for 5 years. Though the bonds will be listed on stock exchanges, do not expect liquidity to be too high.Other forms of gold investment do not come with such restrictions. - The interest earned is taxable. Capital gains taxation is same for physical gold, Gold ETFs, Gold Mutual Funds and gold bonds.
After 8 years, you must redeem the bonds giving rise to capital gains implications. There is no such compulsion in other forms of gold investment.- You have to invest lump sum in these bonds. The present issue is open only for a few days. If you want to invest after that, you have to wait till the next round of issuance before you can buy. You have an option to purchase from the secondary market but the liquidity is low.
To be honest, none of the drawbacks mentioned are serious.
Should you invest in Gold Bonds?
When it comes to regular income (interest), gold bonds beat any other form of gold investment hands down. There is just no comparison. Gold ETFs and mutual funds have a significant expense ratio (1-1.5% p.a.) to take care of too. Jewellery comes with making charges. So, that will compromise the returns.
Above statements would make you think these gold bonds are a no-brainer. Well, that’s not the case. You need to look at suitability of the investment too.
If you are thinking about investing in Sovereign Gold Bond Scheme, there are a few questions that you need to answer.
- Do you want to invest in gold? Or do you want to accumulate for a purpose?
- If you must invest in gold, should you invest in physical gold, Gold Mutual Funds, Gold ETFs, gold Jewellery or sovereign gold bonds?
- What do you really want? Do you want to gold or do you want power to purchase gold whenever you want to?
Gold is a speculative asset. When you try to value a stock or a bond, you discount the future cash flows at an appropriate discount rate to arrive at the present value. Gold does not generate any cash flows. As I understand, gold derives its value more from how the other asset classes are performing. In my opinion, gold as a percentage of your portfolio should not exceed 5-10%. So, if you already have say, 10%, in gold, there is no need for you to invest further in gold. You can simply give gold bond scheme a pass.
If you want to accumulate for, say your daughter’s wedding in the next 5 years, gold bond scheme will not fit the bill. In such a case, you are better off buying physical gold. Rather, go and purchase jewellery. And keep in a bank locker. No one can tell where gold prices will be in a few years. But, jewellery making charges will certainly experience inflation.
If you want to trade in gold or want to benefit from fluctuations, Gold ETF or gold mutual funds are better. ETFs will offer much better liquidity. However, do note not all Gold ETFs have good liquidity.
If you plan gold to accumulate gold for your daughter’s marriage which is atleast 15-20 years away, forget about all the gold investments and invest in equity funds.
A number of people start purchasing gold for their children’s marriage just after they are born. Now, think about it, the marriage of a new born is at least 20-30 years away. If you are purchasing gold only for the marriage, you can purchase gold at the time of marriage itself. Why do you need to start accumulating from day one? You should do equally well if you have enough money to purchase requisite gold at the time of marriage.
In that case, all you want is the power to purchase gold at the time of marriage. Purchase of gold jewellery for your daughter’s marriage after 25 years could be one of your goals and you can start investing for the goal just like other financial goals. As you get closer to your goal (or when gold price falls sharply), keep liquidating equity investments gradually and start purchasing gold/gold jewellery with the money. This is of course with the assumption that equity investments will outperform gold over the long term.
PersonalFinancePlan Take
Despite the fact that gold bonds offer regular interest income, these bonds somehow do not seem to fit any requirement of gold purchase or investment. For short term usage, physical gold or jewellery suits the best. To benefit from gold prices fluctuations, ETFs fit the bill. In both cases, gold scheme loses out because of liquidity constraints. For long term goal or gold usage, in my opinion, a mix of equity funds is the best way to go.
The only place where I see gold bond scheme can fit in your portfolio is where you want to invest in gold for diversifying your portfolio. That will give your portfolio some hedge against extreme economic local or global turmoil along with a regular (albeit small) interest income. Gold can be a very good against sharp rupee depreciation too. So, you can invest in Sovereign Gold Bonds to diversify your portfolio.
On a different note, sometimes, we tend to make things too complex. Not every decision can be looked at from a financial angle. Data analysis and number crunching in excel sheets can only take you so far. Emotional and psychological aspects play a crucial role in decision making. For many Indian women, gold is much more than investment. It is a tool of empowerment. I am quite sure my mother will be many times more comfortable holding physical gold than gold bonds or gold ETFs. An interest rate of 2.75% p.a. is unlikely to change to her opinion.
For more details about Sovereign Gold Bond Scheme, please read the RBI Circular and FAQs on gold bonds.
Image Credit: Jeremy Schultz, 2007. The original image and information about usage rights can be downloaded from Flickr.
Deepesh is a SEBI registered Investment Adviser and Founder, PersonalFinancePlan.in