The Reserve Bank of India has released the calendar for Sovereign Gold Bond Scheme, 2020-2021. The Bonds will be available for subscription in 6 monthly tranches from April 2020 to September 2020.
For the tranche that is now open for subscription in April 2020, the subscription price is Rs 4,639 per gram. For online subscription, there is a discount of Rs 50 per gram.
Should you invest?
How Sovereign Gold Bond (SGB) Scheme works?
This is best understood with the help of an example.
- You purchase 50 units of Sovereign gold bonds (or 50 SGBs). Each SGB unit is equivalent to 1 gm of gold.
- You get interest on the total purchase amount.
- At the time of maturity/redemption, you get the prevailing price of 50 grams of gold.
For instance, if you bought 50 units at Rs 4,000 per gram (total investment of Rs 2 lacs) and the prevailing price at the time of redemption is Rs 6,000 per gram, you will get back Rs 3 lacs. Alternatively, if the price prevailing at the time of redemption is Rs 3,000 per gram, you will get back Rs 1.5 lacs.
In addition, you earn an interest income of 2.5% per annum. Interest will be calculated on your investment value (and not on the prevailing price of gold). In this case, you will get Rs 2,500 every six months until bond maturity.
Important Features of Sovereign Gold Bond Scheme (2020-2021)
- The Minimum Subscription is 1 Bond (1 gm of Gold)
- The Maximum investment limit is 4 KG of gold (4,000 SGBs) per financial year.
- Only Resident individuals, HUFs, Trusts, Universities and Charitable Institutions.
- Non-resident Indians (NRIs) can’t invest in Sovereign Gold Bonds.
- Interest income of 2.5% p.a. The interest is paid out on a semi-annual basis.
- The subscription price is the simple average closing price of gold of 999 purity, published by IBJA for the last three working days (preceding the week of issuance).
- Your investment will be redeemed at the prevailing price of gold. You will not get back physical gold.
- The price for redemption/maturity shall be calculated in the same manner.
- Sovereign Gold Bonds are backed by Government guarantee. Hence, there is no credit risk.
- However, there is price risk. The value of your investment will change with the price of gold.
- The bonds will be listed on BSE and NSE. Hence, you can exit before maturity in the secondary market too.
- You can take loans against these gold bonds (just like physical gold and jewellery)
- You can apply for the SGBs from your brokerage account.
How can I exit or redeem my Sovereign Gold Bond investments?
Sovereign Gold Bonds mature in 8 years. There is also an option to redeem gold bonds with the Reserve Bank after 5 years on interest payment dates. Note that interest payment is semi-annual.
Thus, you can redeem your investment (if you wish) with the Reserve Bank after 5 years at every 6 months interval (5 years, 5.5 years, 6 years, 6.5 years, 7 years, 7.5 years and 8 years from the date of issuance).
At the time of maturity, you will get back the value of your investment as per the prevailing price of gold. Thus, you carry the price risk.
Let’s say you bought 10 units (10 grams) of SGB at Rs 4,500 per gram. At the time of redemption, the gold price is Rs 6,000 per gram. You will get back Rs 60,000 (10 X 6,000).
On the other hand, if the price at the time of redemption/maturity is Rs 3,500 per gram, you will get back Rs 35,000 (10X 3,500).
How are Sovereign Gold Bonds taxed?
The interest income on Sovereign Gold Bonds are taxed at your slab rate.
The treatment of capital gains on Sovereign Gold Bonds is the same as for the physical gold.
If you sell Sovereign Gold bonds in the secondary markets before completion of 3 years (holding period), the resulting gains will be short term capital gains and taxed at your marginal tax rate.
If you sell Sovereign Gold bonds in the secondary markets after completion of 3 years (holding period), the resulting gains will be long term capital gains and taxed at 20% after indexation.
What about redemption?
Here, you have an interesting twist.
There is no capital gains tax on redemption (or maturity). Note this relief is only for individual investors (Section 47 of Income Tax Act).
Therefore, you may buy SBG at Rs 4,500 per gram and redeem with RBI after 8 years at Rs 6,500 per gram. You will NOT have to pay any capital gains tax. Remember, you can redeem SGB after 5 years on 6-month intervals too. There shall be no tax on such redemptions too.
This is to bring taxation of SGB in line with physical gold. In fact, makes it even better for SGBs. In case of physical gold, you can continue to hold as long as you want and thus not pay capital gains tax. However, sovereign gold bonds mature in 8 years. Taxing capital gains on redemption would have been a disincentive. Hence, this provision has been added.
When the SGB matures (or you redeem), you can use the proceeds to purchase another gold bond or physical gold/jewellery or use it for any purchase.
What are the pros and cons of investing in Sovereign Gold Bonds?
Before we get down to the pros and cons, let’s first look at other ways of investing in gold invest in gold and the associated issues. And how SGBs fare against them.
- Physical gold (Storage can be a problem but manageable. Purity)
- Gold Jewellery (Bad choice as an investment since you incur making charges)
- Gold Mutual Funds (Expense ratio. Wide variance in performance of gold mutual funds)
- Gold ETFs (Expense ratio, low liquidity, impact cost, Price and NAV difference)
None of the above forms of gold pays you interest income. Only Sovereign Gold Bonds do.
Unlike Gold mutual funds and gold ETFs, you do not have to incur any expenses. I checked the expense ratio was close to 1% for some funds and ETFs.
There is an additional benefit with Sovereign gold bonds. As I understand, all the above forms of gold will include the impact of 3% GST on buying gold. Remember, even gold mutual funds and ETFs must buy the underlying gold. With Sovereign Gold Bonds, since there is no underlying gold (we believe in Government’s promise to match the Gold price), there is no GST impact.
That’s for the good part.
Sovereign Gold Bonds are not without a problem. You may face issues if you must sell in the secondary market.
Liquidity is a problem in the secondary market. This may mean higher impact cost (difference between bid and ask spread). In the worst case, you may just not be able to sell or may have to sell at a heavy discount.
There are many reasons for lower liquidity in the secondary market. First, there are many SGB issues that are traded on the market. Therefore, the demand gets spread across many investments. Secondly, the RBI issues SGBs almost on a monthly basis. Hence, potential buyers can directly subscribe to the new issue than buy on the exchange (unless they can buy something on the exchange at high discount).
Earlier, there was an issue with inter-depository transfers (between CDSL and NSDL) too. Thus, most brokerage firms didn’t allow you to buy in the secondary market (though they allowed to sell). As I understand, this is no longer a problem.
Whatever the reason be, the liquidity is low in most issues. Some issues hardly even trade. You can find information about the trading volumes on NSE website. As a seller, this information may not be as useful. You can sell only what you hold. However, as a potential buyer, you must consider this aspect. At the same time, keep an eye on actual gold price levels before you go and place a buy bid. Also, note that the SGBs have an interest component too. The difference is not just in interest rate (earlier the interest rate offered was 2.75% p.a. The interest you earn depends on the subscription price. Factor these aspects in while placing your bid.
When should you use Sovereign Gold Bonds?
If you are investing for a goal many years away, say daughter’s marriage, SGBs are perfect. You can simply buy and hold. You can reinvest in a fresh issue when the bond matures. When closer to the goal, you can simply use the proceeds to purchase gold/jewellery.
If you are investing in Sovereign Gold Bonds for diversification, low liquidity can pose challenges. For instance, if you must rebalance portfolios and have to buy/sell bonds in the secondary market, it can a problem (Gold ETFs or gold mutual funds score here). However, in my opinion, this shouldn’t be a problem for most portfolios (especially when you are in the accumulation phase). I assume you can’t forecast gold prices with accuracy. Adding gold bonds to the portfolios is not a problem since RBI comes with fresh issues almost on a monthly basis. Reducing will also not be a problem if you have been adding gold bonds gradually since you can redeem with RBI after 5 years at 6-month intervals. I will suggest SGBs for portfolio diversification too.
If you are investing in gold to benefit from short term movements, Gold ETFs or gold mutual funds are better compared to SGBs. Nippon India ETF Gold BeES can be a good option (since there is decent liquidity and ETFs don’t have exit load either).
Is the price for Gold too high?
I don’t know if the current gold price is too low or too high. I understand this can be a concern since the Gold prices have shot up over the last year.
Personally, I believe gold should do well in times when the central banks around the world are printing money. There is momentum too. However, you can discount my opinion on gold price levels. Such first-order thinking usually does not work with investments.
As an investor, the price should not be too big a concern Assuming you must take incremental exposure to gold for portfolio diversification or any other reason, you can simply stagger your investments just like you do for equity investments. You can expect RBI to come out with such issues for a foreseeable future.