Should you invest in Sovereign Gold Bond?

With Prime Minister Narendra Modi officially launching three gold related schemes - Gold Monetisation Scheme (GMS), Gold Sovereign Bond Scheme and the Gold Coin and Bullion Scheme- today, Indians can consider buying paper gold or a national coin over imported coin, this Dhanteras. 

 

However, from an investment perspective, it would be worthwhile to consider if paper gold is worth a buy as compared to physical gold?

Background

With one gram of gold pegged at Rs 2,684 for bonds, paper gold comes with a lock-in period of eight years, for which the government will be compensating at a fixed rate of 2.75% per annum payable semi-annually on the initial value of investment. The application for bonds which will be sold through banks and designated post offices is being accepted from today onwards till November 20, 2015. 

From tax perspective, the interest on Gold Bonds is taxable as per the provision of Income Tax Act, 1961 (43 of 1961). The scheme also attracts capital gains tax which remains the same as in case of physical gold.

Expert Take

According to Suresh Sadagopan, Founder of Ladder7 Financial Advisories, "SGB is a win-win option for somebody who is investing in gold as a part of portfolio diversification. This scheme is very lucrative for those who have been investing in Gold ETFs, all this while. Other than the appreciation in gold prices and 2.75 per cent interest provided, one also stands to gain an additional upto 1 per cent, which was the expense ratio charged in ETFs."

Surely, a 3.75 per cent return on gold which was thus far a dead investment (lying in locker), is bound to entice many this Diwali. But before you make a dash to subscribe, please note the taxation angle to the product as well. 

In effect it means that interest earned on gold will be added to income and is taxable as per one's tax slab. Incase, the bonds are sold before three years, the gains are taxable as per one's tax bracket. If sold after three years, then gains would be treated as long term capital gain wherein a tax rate of 20% with indexation is applicable.

"The tax aspect of the scheme will be a dampner and in many ways it will act as a deterrent when it comes to retail investors," is what Gajendra Kothari, Managing Director & CEO of Etica Wealth Management had to say about the Scheme. Apart from this, he cited the lack of liquidity as another negative of SGB. 

One may think that since these gold bonds will be tradable on exchanges, it will be technically easy to liquidate. Kothari's liquidity concern stems from the fact that if we were to go by the history of bonds and FMPs which is listed on the exchange, it has been observed that hypothetically you can liquidate but practically it is very difficult. In such a scenario, it remains to be seen how the liquidity of SGB will pan out. 

Hemant Rustagi, CEO of Wiseinvest Advisors points out to another negative aspect of gold bonds. "Since these bonds are open for subscription for a limited time, it means that the investor is forced to buy at a pre-determined rate, thereby losing out on the chance to buy at a probable lower rate." For example: For the first tranche, RBI has announced the gold bond rate announced for 1 gram at Rs 2,684, and within a week's time the price has dropped to Rs 2,588 per gram. In effect the investor loses out on the opportunity to take advantage of the volatility in gold price, which is otherwise possible with ETF. 

Another negative that works against the scheme is the 2.75% interest is calculated on the amount invested and not on the maturity value. Hemant adds that given the lock-in period of five years, the post tax return is not worth considering. Back-of-the-envelope calculation shows that gold bonds are likely to outperform ETFs by 2.6% for a 20% tax slab individual and by 2.4% for a 30% tax bracket individual.

Surya Bhatia, Certified Financial Planner too concedes that given the way the Scheme is structured it is very hard to really predict how many investors will really go and bite the bullet and go for the scheme. Given that Indians intrinsically love gold, it's only a matter of time when you can really see and judge how this scheme is taken by the people. Going by the response, I think the government is likely to go back to the desk and see how much more change needs to be brought over to really make it more widespread. 

In the light of these numbers, financial advisors opine that if you are a long term player with an aim to have proper asset allocation or portfolio diversification in place, then SGB is for you. Otherwise, one can give this scheme a miss. Given the inherent tax aspect, only time will tell how far this scheme will be successful because Indians buy gold for cultural and emotional reasons rather than for investment purpose.

Taxation on Gold ETF

Suppose an investment of Rs 50,000 was made in Gold ETFs in November 2010 and if you were to sell it in November 2011. Your gains would be as follows

During the same time, gold prices had appreciated from Rs 20,538 to Rs 29,061, clocking in an impressive return of 41.5%

Gains on investment - Rs 20,750

Tax (assuming lower tax bracket of 10%) - Rs 2,075