In a market that has dramatic swings from one day to the next, investors must learn ways to diversify their portfolios that will win in any market. With the Covid-19 pandemic battering world markets, equity investors are suffering. The spike in bond yields has resulted in losses to investors of debt instruments such as debt mutual funds. However, one asset class that has delivered positive returns so far is gold, and allocation to the yellow metal may have restricted your overall portfolio losses.
Gold Prices Move Very Slowly. How Can It Possibly Help in Wealth Creation?
That is the standard refrain. After all, over long periods of time, gold hardly moves. It is only during short spurts like 1971 to 1979 and 2006 to 2011 when gold has given attractive returns. The logic is; if gold has outperformed only twice in a span of 50 years then is it worthwhile considering gold as an asset class? More importantly, does it really qualify to be part of your financial plan? Let us find the answer.
Following graph shows the movement in gold price over a period of 9 years since Sep-11 till Sep-20.
In the initial years, the price moved at an annual compounded rate of 4%. However, after Covid-19 hit the world, the gold prices spiked 37% in one year from Sep-19 to Sep-20. This effectively increased the CAGR to 8% over a period of 9 Years from a mere 4% over a period of 8 years.
So, our answer is “Yes”.
There is no consensus on the next “what” and “when” and “what” will cause the equity and debt market to tank. Hence, gold is an important inclusion in any portfolio.
When one talks of including gold in the long-term portfolio the idea is not to outperform the market. The focus is more on diversification than on enhancing returns or wealth creation. Gold has no intrinsic value as it does not earn anything nor does not generate any returns. The price movement is normally a demand/supply equation.
Advantages of Including Gold In Your Portfolio
- It is the best bet in turbulent times
Historically, gold has typically outperform during times of turbulence and uncertainty. The period between 1971 and 1979 was a period of tremendous economic and geopolitical turmoil. It was during this period that gold rallied from $35/oz to $800/oz. The next period of gold appreciation was between 2006 and 2011 when a combination of the sub-prime crisis, the Lehman crisis and the European debt crisis made gold extremely valuable.
Gold is not only immune to inflation, but it also serves as a hedge against economic disaster. When the rest of the stock market falls, gold often goes the other way, appreciating in value and protecting the smart investor against major losses in other financial assets. It gives investors insurance against geopolitical events, uncertainty, and inflation. For those reasons, investing 10-15% of your portfolio in gold is always recommended.
- Hedge against inflation
Gold brings a special element into a portfolio, one that makes it different from all other metals. Prices of gold, which is known to act as a hedge against inflation, generally go up in times of uncertainty like what we are seeing at present. Gold is recommended in a portfolio because it tends to go up when everything else goes down. Owning gold is not about upside potential. It is about minimizing risk to the downside.
- Gold has the longest surviving secondary market.
This is an interesting aspect about gold. Historically, it has been the longest surviving secondary market. That is because gold never goes out of demand and is a global product. The Dow Jones index over the last 70 years or the Sensex over the last 30 years will have have different components. New stars have risen, and old stars have fallen along the way. Therefore, any investment in equity and mutual fund runs the risk of market churn. Gold is probably the only asset that is free from the risk of churn. You can be confident that even after 30 years there will be a robust secondary market for gold.
How to Invest in Gold?
When we talk of gold we are not talking about the gold in your jewellery; but we are talking of gold as an investment. This includes gold in the form of bars or gold in the form of e-gold or even in the form of gold bonds. In short, any product that helps you to mirror the price of gold can be included as gold investment.
- Gold ETF
If you have a demat account, you can invest in gold exchange-traded funds (ETFs). Gold ETFs is like buying physical gold, but the only difference is you do not actually buy the physical gold. You do not have to go through the hassles of storing the physical gold, instead, the gold bought is stored in Demat (paper) format.
- Gold Fund
Gold funds are a good option for those who don’t have a demat account as you can buy and sell these funds just like you do with any other mutual fund scheme. You can also opt for gold funds which invest in gold ETFs. Also, these funds allow regular investment through systematic investment plans, so you don’t have to invest in one go. Funds make the investment in the form of bullions and the companies involved in gold mining.
- Sovereign Gold Bond
If you are looking for a long-term investment, sovereign gold bonds (SGBs) are one of the best options available. By investing in these, you not only benefit from the appreciation in gold prices but will also earn an interest income. Apart from this, SGBs are tax efficient as there is no long-term capital gains tax to pay if you redeem these bonds on maturity. However, remember that exiting them before the maturity period of eight years can be a little difficult. You can exit before maturity through the exchange, but the bonds may not be liquid enough.
- Digital Gold
In the pandemic, another method of investing in Gold that has been gaining immense popularity is in the form of Digital Gold where companies allow you to invest in gold on a regular basis and accumulate over time. Once you invest in digital gold, the companies purchase an equivalent amount of physical gold and store it under your name in secured vaults. This gives you the option of taking the physical delivery of gold once you have accumulated a minimum quantity.
Currently, there are three companies that offer digital gold in India-
- Augmont Gold Ltd.
- MMTC-PAMP India Pvt. Ltd. a joint venture between state-run MMTC Ltd. and Swiss firm MKS PAMP.
- Digital Gold India Pvt/ Ltd with its SafeGold brand.
Apps and websites like Paytm, G-Pay etc only provide a platform for metal trading companies SafeGold and MMTC PAMP. Once you invest in digital gold, these trading companies purchase an equivalent amount of physical gold and store it under your name in secured vaults. You can choose to sell your gold digitally itself to the platform whenever you want. In case you chose to not sell the gold, you can request for a doorstep delivery of your gold in the form of coins or bullion.
While there are many advantages of digital gold, following are some disadvantages:
- Limit of Rs.2 lakhs for investment on most platforms.
- Lack of an official government-run regulating body such as RBI or SEBI.
- Delivery and making charges are further applied to the price of gold.
- In some cases, companies only offer a limited storage period, after which you either have to take physical delivery or sell the gold.
Summary of pros and cons
Following table compares the advantages and disadvantages across all the modes of investing in gold in India:
|Concerns/Issues in gold investment||Physical Gold||Gold ETF/Gold Fund||Sovereign Gold Bond||Digital Gold|
|Storage cost||High||Low||Yes Low||Low|
|Safety||Risk of theft, wear and tear||High||Yes High||High|
|Purity||The purity of gold always remains a question||High as it is in electronic form||It is High as it is in electronic form||High as it is in electronic form|
|Insurance||No||No||Not; however, sovereign guarantee available||Yes|
|Cost||Making charges make it less cost effective||Very cost efficient; no making charges||Very cost efficient; no making charges||Making charges make it less cost effective|
|Interest Earned||Nil||Nil||2.75% on initial purchase value payable semi annually||Nil|
|Minimum Holding Period||None||None||8 years; partial exit allowed starting 5th year.||None|
|Taxation||For the gold investments above Rs.30 Lakh, a wealth tax @ 1% is imposed every year;Capital gains tax of 20% if sold after 3 years and at marginal rate if sold before 3 years||Capital gains tax of 20% if sold after 3 years and at marginal rate if sold before 3 years||Very tax efficient – On maturity, the proceeds are exempt from capital gains tax. Interest from SGB is taxable at marginal rate.||Capital gains tax of 20% if sold after 3 years and at marginal rate if sold before 3 years|
|Collateral||Accepted as collateral by gold loan companies||Not accepted as collateral||Accepted by some banks as collateral||Accepted as collateral|
|Return/Earnings||Lower than the real return on gold due to making charges||Less than actual return due to expense ratio, tracking error||More than actual return on gold due to interest||Lower than the real return on gold due to making charges|
|Tradability or exit formalities||Restrictive||ETFs tradable on stock exchange and gold funds can be redeemed like regular funds. Redemption will be subject to exit load.||While it can be traded on exchange, the liquidity remains low||Exit options – can be sold anytime to the platform; otherwise investor has option to request for physical delivery|
The idea that jewellery is an investment is storied but naïve. There is too much of a spread between the price of most jewellery and its gold value for it to be considered a true investment. Instead, the average gold investor should consider gold ETFs, sovereign bonds or digital gold, as these securities generally provide the easiest and safest way to invest in gold. There are a lot of ways to invest in gold in India and it depends on your choice of mode of investment for what returns you get on your investments.
Is It the Right Time to Invest in Gold?
Gold prices have rallied ~37% on the domestic front over the last one and a half year and the major question hovering in the mind of investors, therefore, is: Have gold prices peaked or is there some steam still left?
Market experts believe that for Indians, there is no right or wrong time to purchase or invest in gold. The consumption of gold in India is need-based (marriage, religious functions, and the matter of pride) rather than investment-based. Hence, the rationale of right time or right price does not fall well in place for gold consumers in India.
There are some factors that can support growth in gold prices going forward:
- Liquidity push by central banks across the world will support growth in gold prices
- Investment demand in gold has seen a drastic increase since the start of 2019 while the supply of gold remains finite. The investment demand as seen in the net additions of ETF holdings also signals that gold will shine for a much longer time even if the pandemic is under control.
- Dearth of returns in many other asset classes will drive money towards gold. Though currencies may be stable against each other, but they will lose their value against gold.
With the global output to contract and the economies in a deeper recession than most anticipate, gold as an asset class is a safe bet for investors across the globe. Although, the physical demand has declined drastically due to the restrictions and lockdowns, the activity of global central banks and their net purchases of gold signal that uncertainty will continue for most of 2020, say experts.
- Gold is an important part of the portfolio to provide a hedge against political or economic unrest and inflation.
- It is an ideal inclusion in the range of 10% – 15% of your portfolio to lower the overall portfolio risk.
- There is no right time for investing in gold since the investment is to achieve the objective of hedging against unforeseen situations which drastically affect your equity and debt holdings.
- The most direct way to own gold is to purchase physical gold bars or coins, but these can be illiquid and must be stored securely.
- ETFs, sovereign bonds, digital gold are also gaining popularity as modes of investing in gold
Also read: Retirement planning