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In 2024, gold delivered a strong return of approx 21%. It holds significant importance in Indian culture and serves as a reliable portfolio diversifier. As a safe investment, gold helps spread risk across different asset classes and provides protection during uncertain times. It can also safeguard wealth during market downturns or geopolitical tensions. In this article, we will discuss what is gold ETF, its types, purpose and may more.
What Are Gold ETFs and How Do They Work?
Gold Exchange Traded Fund or ETF is a type of mutual fund that tracks the price of physical gold. These funds invest in 99.5% pure gold and allow investors to own gold digitally without physically storing it. Each Gold ETF unit represents one gram of gold or a fraction of it.
Gold ETFs offer a convenient way to invest in gold, combining the benefits of gold ownership with the flexibility of stock trading. Instead of buying, storing and securing physical gold, investors can trade Gold ETFs on the stock exchange like any other stock.
These ETFs were created to overcome the limitations of physical gold investments such as storage, security and liquidity concerns. Gold ETF provides an efficient, low cost and transparent way to invest in gold.
Gold ETFs track gold prices, so when gold prices rise or fall, the value of your investment changes accordingly. To invest in Gold ETFs you need a demat and trading account. You can buy or sell units during market hours, with transactions settled electronically. There’s no need to worry about storing or securing physical gold since the fund holds it for you.
Gold ETFs are passively managed, offering transparency, low costs and high liquidity. This allows investors to easily buy or sell units and gain exposure to gold prices without the hassle of handling physical gold.
Purpose of Gold ETF
Gold ETFs offer investors an efficient way to invest in gold without owning physical metal. These funds are designed to track the price of gold providing an easy and liquid method for investors to gain exposure to the precious metal.
- Portfolio Diversification: Gold ETFs help diversify an investment portfolio by adding exposure to the gold industry. This diversification can extend to sectors related to gold mining, manufacturing and transportation.
- Hedge Against Market Fluctuations: Gold is often used as a hedge against economic instability and market volatility. Investing in gold ETFs can protect an investment portfolio from inflation, economic downturns or currency depreciation.
- Defensive Asset: Gold ETFs are considered defensive investments similar to bonds. They can help safeguard wealth during times of economic uncertainty. Gold’s value often rises when major currencies such as the dollar weaken allowing investors to benefit from these shifts.
- Ease of Trading: Gold ETFs are traded on NSE and BSE. Investors can buy or sell these gold ETF during market hours at prevailing prices, making them highly liquid and accessible.
Before purchasing Gold ETFs, ensure you understand their pricing, expense ratio, tracking accuracy, and overall fit with your investment goals.
Types of Gold ETFs, Examples and how they work
- Physical Gold ETFs
A Physical Gold ETF is a type of exchange-traded fund that invests directly in gold bullion. It holds physical gold bars, coins or bullion in a secure vault on behalf of its investors. Each unit of the ETF represents a proportional share of the gold reserve. As the price of gold changes value of the ETF fluctuates accordingly. Some well known examples include Nippon India ETF Gold BeES and HDFC Gold Exchange Traded Fund (ETF).
- Gold Mining ETFs
Gold mining ETFs invest in companies that are involved in gold mining, providing exposure to the gold industry. These ETFs may focus on large gold producers or smaller, emerging mining companies. While large producers offer more stability, smaller mining firms present higher growth potential but also carry greater risks due to their smaller size, weaker financials and operational challenges. This diversification can help investors gain exposure to the gold market through company shares rather than directly investing in physical gold.
- Leveraged Gold ETFs
Leveraged gold ETFs use financial tools like futures contracts and leverage to enhance gold price movements. These ETF aim to provide returns that are double or more compared to the underlying gold price changes. These ETFs can take both long and short positions, offering investors the potential for higher gains but also increased risks because of leveraged involved. Examples include UGL, DGP, GLL and DZZ.
- Inverse Gold ETFs
Inverse or Short Gold ETFs are designed to provide the opposite performance of gold prices. These funds achieve this by using futures contracts which allow them to effectively create a short position in gold. For example, If gold prices decrease by 1%, Inverse gold ETF aims for a 1% gain. These ETFs are popular among investors looking to profit from declines in gold prices or hedge against potential losses in their gold holdings.
Note: the examples and types of gold ETFs are primarily used in global markets, so the example belongs to other country exchanges. There are only Physical gold ETFs in India.
Advantages and Disadvantages of Gold ETF
After the types of gold ETFs, let’s understand the benefits of investing in gold ETFs.
Advantages of Gold ETF
- High Purity and Quality: Each unit of a Gold ETF is backed by physical gold of high purity, ensuring reliable quality.
- Transparent Pricing: Since Gold ETFs are traded on stock exchanges, their prices are transparent and reflect real-time gold rates.
- Tax Efficiency: Gains from Gold ETFs are taxed as long-term capital gains, which is tax-friendly for investors.
- No Additional Taxes: You don’t have to pay wealth tax, VAT, sales tax or securities transaction tax on Gold ETFs.
- Secure Storage: Gold ETFs are held in your Demat account, eliminating the risk of theft and saving you the cost of locker charges.
- Loan Collateral: Banks accept Gold ETFs as collateral, offering additional financial flexibility.
- Easy Trading: You can buy and sell Gold ETFs easily, without paying entry or exit loads or additional fees.
Disadvantages of Gold ETF
- No Physical Ownership: Investors do not own actual gold. They hold units representing gold’s value.
- Price Fluctuations: Gold ETF prices are influenced by market conditions and may change even if gold prices remain stable.
- Management Fees: Gold ETFs charge management fees which can slightly reduce returns over time.
- Account Requirement: Demat and trading account is necessary to invest, which may not be convenient for all investors.
- Liquidity Issues: Some Gold ETFs may have low trading volumes, making it difficult to buy or sell units quickly.
- No Emotional Value: Unlike physical gold, which may carry cultural or sentimental importance, Gold ETFs lack emotional significance.
Things to consider before investing in gold ETF
The following things are must consider while investing in gold ETFs:
Investment Horizon
Gold ETFs are more suitable for medium to longterm investments. Historically, they have provided an average return of around 10% annually over the long term. However, short term trading based on market conditions can also yield benefits.
Fund Selection
Do not make your choice solely on low tracking errors. Review the fund’s historical performance and assess how effectively the fund manager handles investments before making a decision.
Cost Efficiency
Gold ETFs are more cost effective than physical gold especially for large investments or frequent trades. This makes them a smart choice for reducing storage and transaction costs.
Portfolio Allocation
Limit your Gold ETF allocation to 5% to 10% of your total portfolio. This diversification strategy helps stabilise your overall investment portfolio.
Brokerage and AMC Fees
Gold ETFs generally charge between 0.5% and 1% in brokerage or management fees. Compare different brokers and Asset Management Companies or AMCs to find reasonable and competitive rates.
By considering these factors, you can make informed decisions and maximise returns when investing in Gold ETFs.
Gold ETF Taxation: How Are Gold ETFs Taxed?
Investing in Gold ETFs in India follows similar tax rules to physical gold. The capital gains tax depends on how long the investment is held:
- 1. Short Term Capital Gains (STCG): If you sell Gold ETFs within 12 months of purchase, any gains are considered short term. These gains are taxed at your applicable income tax rate.
- 2. Long Term Capital Gains (LTCG): If the holding period is 12 months or more, the gains are classified as longterm. LTCG on Gold ETFs is taxed at 20% with indexation. Indexation adjusts the purchase price to account for inflation, reducing the taxable portion of the gains.
After a tour of gold ETF investing, you are better equipped with what is gold ETF. Gold etf how it works and benefits of investing in gold ETF.
Final Words
Gold ETFs provide a modern, hassle-free way to invest in gold, offering benefits like transparency, liquidity and potential tax advantages. A prudent allocation of 5–10% can help balance risk and returns. By opting for Gold ETFs you can enjoy the advantages of gold investing without the complications of handling physical assets. Thorough research and informed decisions can ensure gold remains a valuable part of your investment strategy.
Frequently Asked Questions
Can I convert gold ETF to physical gold?
Yes, gold ETFs can be converted to physical gold by paying the value difference to the fund house, which will issue a delivery order for the gold.
Where can you buy Gold ETFs?
Gold ETFs are listed and traded on NSE and BSE like a stock of any company and can be bought and sold continuously at market prices.
How do gold ETFs compare to gold bars and jewellery?
Gold ETFs offer greater liquidity and accessibility compared to gold bars or jewellery, which come with higher storage and insurance costs.
Why invest in gold ETF?
Gold ETFs offer transparency, high liquidity and cost efficiency. Backed by high purity gold, they eliminate quality concerns. Gold ETFs are tax friendly, theft resistant and easily tradable through Demat accounts. Plus, banks accept them as collateral.
How is the price of a Gold ETF determined?
Gold ETFs trade on stock exchanges and are backed by gold assets like bullion or futures. Their prices closely track gold’s value if gold rises by 1%, the ETF typically increases by a similar percentage.
How to sell/redeem gold ETF?
Gold ETFs can be sold on the stock exchange through a broker using a demat and trading account. They are ideal for benefiting from gold price movements without holding physical gold. Upon liquidation, investors are paid based on the domestic gold price. Some AMCs allow redemption in physical gold if holdings are equivalent to 1kg or more.
Who should invest in gold ETF?
Gold ETFs are ideal for investors seeking gold exposure without the hassle of storage or purity concerns. Gold ETFs offer tax benefits, no making charges and can be purchased in small quantities, starting from one unit (1 gram).
Happy investing and thank you for reading!
Disclaimer:
This website content is only for educational purposes, not investment advice. Before making any investment, it’s important to do your own research and be fully informed. Investing in the stock market includes risks, and you should carefully read the Risk Disclosure documents before proceeding. Please remember that past performance doesn’t guarantee future results, and due to market fluctuations, your investment goals may not always be achieved.
