SGBs are costly now. How else can you invest in gold?

Our long-time readers will know that sovereign gold bonds (SGBs) are the best way to invest in gold. They are safer, provide tax-free returns at maturity and give 2.5 per cent returns each year that are over and above the price of gold.

So far, so good. However, there's a fork in the soup at this particular point. Since the government has halted fresh launches of SGBs, the earlier batches are being traded at a hefty premium on the stock exchange.

That leaves you with just two other viable gold investment options right now:

1. gold ETFs (exchange-traded funds)

2. gold FoFs (funds of funds).

(We don't consider buying physical gold to be a good idea for a variety of reasons, including storage, security and liquidity.)

So, let's run the rule over gold ETFs and FoFs and determine which option may suit you best.

What are gold ETFs?

Gold ETF is a type of mutual fund that primarily focuses on buying gold.

In this case, fund houses purchase gold from domestic and international banks and store it in their vaults. They then list this gold on stock exchanges as ETFs, issuing units that represent the physical gold held. So, when investors buy these ETFs, they're essentially purchasing a share of the gold stored by the fund.

These funds are traded on stock exchanges just like regular stocks, making it a convenient way to invest in gold without holding the physical metal.

Point to remember
New investors often wonder why the net asset value (NAV) of different gold ETFs varies, even though they all invest in gold. This point should not deter anyone, though. The difference in NAV is simply due to the number of units issued by each fund, even though the underlying gold and its value remain the same.

This example will help you understand better: let's assume Fund Houses A and B both buy gold worth Rs 50 lakh. If Fund House A breaks the gold investment into 50,000 units, each unit's NAV would be Rs 100 (Rs 50 lakh / 50,000 units). Meanwhile, if Fund B issues 5 lakh units, its NAV would be Rs 10 (Rs 50 lakh / 5 lakh units).

What are gold FoFs?

Gold FoFs invest in Gold ETFs rather than holding physical gold themselves. In other words, FoFs have indirect exposure to gold.

The good news is that since the price of gold ETFs is closely tied to the actual price of gold, the returns made through gold FoFs also fluctuate in line with gold prices. Secondly, since FoFs function like regular mutual funds, you don't need a demat account and can invest directly through the fund houses.

The bad news? FoFs can be costly. They typically incur two layers of fees: one for managing the FoF itself and another for the underlying ETFs in which it invests.

Which is better?

It depends. Gold ETFs can work for those who have a demat account and want to invest in gold occasionally.

On the other hand, since gold FoFs function like regular mutual funds, they allow SIP investments, making them a viable option for those who wish to invest regularly in gold and don't have a demat account.

But before you put your hard-earned money in either gold ETFs or FoFs, here are three factors you should consider:

1. Expense ratio
Look for an ETF and FoF with a low expense ratio.

A higher expense ratio can significantly impact the returns of a fund or ETF in the long run.

2. Liquidity (only applicable for ETFs)
Choose ETFs with high liquidity. You can identify their liquidity by checking their trading volumes. ETFs with higher liquidity allow investors to buy and sell ETFs smoothly, thus lowering the risk of delays or unexpected price fluctuations.

3. Premium/discount to NAV (only applicable for ETFs)
The price of an ETF can differ from its NAV due to the following reasons:

• Price depends on demand and supply. If there are more buyers than sellers, it will trade at a premium compared to NAV. Conversely, if more investors are selling the ETF, the price may fall below NAV and trade at a discount.
  
• ETFs may experience larger fluctuations in price relative to their NAVs in times of high market volatility.
  
• ETF prices fluctuate throughout the trading day. This difference in timing can lead to temporary mismatches between the NAV and the market price.

Therefore, it is generally advisable to invest in ETFs whose market prices closely align with their NAV.

There are two ways to check how close an ETF trades to its NAV. One is by checking the iNAV (indicative net asset value) by visiting the fund house's website. For those unaware, iNAV is the real-time estimate of an ETF's net asset value during market hours. The second option is to visit Value Research Online, search for your chosen ETF and go to the 'Return' tab. There, you can see the deviation between an ETF's price and NAV over the years.

Quick recap

• Gold is not a productive investment option.
  
• If you still insist on buying gold, look at sovereign gold bonds.
  
• However, SGBs are trading at a significant premium.
  
• So, opt for either gold ETFs or gold FoFs, depending on your need and after considering the three factors (current market price, liquidity and expense ratio) mentioned in the above section.

Also read: A twist in the gold story

This article was originally published on October 23, 2024.