Should You Buy Sovereign Gold Bond?

  Author: Jai Prakash

From times immemorial, gold has been a preferred investment for Indians. As people’s faith in stocks and other financial investments suffered after the onset of global financial crisis in 2008, people all over the world started investing in gold. In India, periods of high inflation increased people’s clamour for gold investments. As a consequence, this has impacted the growth of financial investments like equities, mutual funds and debt instruments like bonds, among others. As a result, this limited the money available in the Indian economy to fuel its growth. This was one of the major reasons why the government came up with the Sovereign Gold Bonds (SGB) Scheme.

 The idea behind SGB has been to discourage people from buying physical gold and instead invest in a financial investment linked to gold. This brings us to the obvious question: “Should you invest in the Sovereign Gold Bonds?”

Benefit from efficient gold investment Investing in physical gold has many problems. SGB, or the gold bond, bypasses them. When you buy a gold bond instead of physical gold you do not incur safekeeping costs. Remember, you need to lock up your physical gold in a bank locker. Also, in a gold bond, there is also no fear of the usual gold impurity or loss from making charges.

Better return than physical gold The government has promised an interest payout of 2.5% per annum on gold bonds which will be paid semi-annually. In contrast, in physical gold, you only get capital appreciation.

Long holding period helps in a stable return The gold bond is issued for a period of 8 years. This long period saves investors from any volatility during the bond’s tenure as over the long term the chance of any capital loss reduces substantially.

Liquidity option through exchanges SGB provides exit option after five years. These bonds can be traded on stock exchanges. This can help people who need the cash earlier. However, if you sell these bonds before maturity you would lose the tax benefits and need to pay taxes on the gains.

Tax free return The gains made from these gold bonds are totally tax exempt, if held till its maturity of eight years. However, if you sell or transfer it earlier, long term capital gains tax will have to be paid after taking into account inflation indexation of capital gains.

Risk of stagnation While in the bond’s eight year period, chances of capital erosion are very low, there remains the risk of stagnation of value. For instance, the gold price was Rs 3,939 per 10 gram at the end of 1994 and, after eight years, at the end of 2002, the gold price was at Rs 4,286 per 10 gram, or a return of mere 8.8% in eight years. This translates to an annual compounded growth of 1.06%. Historically, gold has gone though such long periods of stagnation.

Have limited exposure While the interest paid on the Sovereign Gold Bond is attractive, it does get balanced out by the risk of stagnation in the gold investment’s value. We, at FundooMoney, feel that you must have a very limited exposure to these bonds. In any case, all your gold, gold-related and commodity investments including gold exchange traded funds (ETF) should not cross 10-15% of the value of your total investments at any time.