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Should you buy Sovereign Gold Bonds?

The latest series of Sovereign Gold Bonds is available for subscription till January 17. Find out if you should buy them

Should you buy Sovereign Gold Bonds?

The latest series of Sovereign Gold Bonds (SGBs) is open for subscription and you can buy them until Friday, January 17. Most banks let you buy the bond online using their internet banking facility. Otherwise, they can also be bought from the stock exchange or the post-office. Though the bonds are priced at Rs 4,016 per gram, buying them online makes you eligible for an instant discount of Rs 50 per gram.

While Indians have had a love affair with gold that spans generations, the shiny metal has also caught the fancy of many investors on account of the 21 per cent returns it has delivered in the last one year. So does that make SGBs an attractive investment proposition?

Well, before we talk specifically about SGBs, let's first look at gold as an investment alternative. It may have given super returns in the last year, but its long-term performance isn't all that glittering. Look at the graph below which compares the returns of gold funds with those of equity multi-cap funds across different time periods. As you can see, equity beats gold handsomely over longer time frames.

Should you buy Sovereign Gold Bonds?

Not only do the returns on gold tend to be worse than those on other investments historically, but this will likely remain the case always. That's because gold belongs to a class of investments that does not actually produce anything or create any value. Any rise in its worth is based on the belief that when the time comes to sell it, someone else will pay more. Unlike equity or bonds or deposits, the money that you invest in gold does not contribute to economic growth. An equivalent amount of money deployed in a business or any other productive economic activity will generate actual wealth and will grow larger in a very fundamental way, while a given quantity of gold will just remain the same. For these reasons, we don't think of gold as a suitable asset class for wealth creation.

But a lot of people find it difficult to accept that gold is not a good investment because we instinctively think of gold as permanent wealth, a currency that has survived all kinds of historical troubles. It is often viewed as a protection against the bad times.

If you'd like to allocate some portion of your money to gold for this reason, then clearly SGBs are a better option than holding it in its physical form or even investing in gold funds and ETFs.

Here's a comparison of these three main modes of holding gold on the key parameters of returns, taxation, cost of ownership and liquidity. As you can see, the SGB trumps the other two on the first three parameters but lags on the liquidity front.

Should you buy Sovereign Gold Bonds?

The main advantage of SGBs is that they give you a guaranteed interest of 2.5 per cent per annum. It is paid out once every six months. You get this interest in addition to the price appreciation of gold. Therefore, by buying SGBs, you immediately have a 2.5 per cent per annum advantage over gold funds or even holding it in its physical form. The price of SGBs is linked to the price of real gold. It is based on the average of the closing price of gold of 999 purity published by the India Bullion and Jewellers Association Limited for the preceding three working days.

Here again, SGBs have a huge advantage. The capital gains realized on the redemption of the bond at maturity is tax-exempt. SGBs have a tenure of eight years, and the gains realized due to the appreciation in price over this period are completely tax-free provided you hold them till maturity.

Gold funds and physical gold, on the other hand, attract capital gains tax at the rate of 20 per cent after providing the benefit of indexation if you sell them after three years of holding. If you sell them before that, the gains are added to your income and taxed at the applicable slab rate.

However, we'd re-iterate that this tax advantage accrues only if you hold SGBs till maturity. If you sell them before maturity, you will have to pay capital gains tax similar to gold funds or physical gold.

Cost of ownership
While you do not need to incur any additional cost for holding SGBs, you pay an annual expense if you invest in gold funds. Gold ETFs and their fund-of-fund variants can charge upto one per cent per annum. Physical gold also does not attract any incremental cost unless you opt to incur some cost for its safe storage, such as the charges for a bank locker.

This is an area in which SGBs fare relatively poorly. For the first five years, you can only exit from SGBs by selling them on a stock exchange. However, historical trading volumes suggest they are not traded very actively. After five years, they can be redeemed directly with the RBI. Gold funds, on the contrary, offer much better liquidity. Even physical gold can be sold at a jewellery shop fairly easily.

So there you go! If you do make up your mind to go for SGBs, here's a summary of their key features.

Should you buy Sovereign Gold Bonds?