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| Gold ETFs are not as volatile as stocks |
| BS Reporter / Mumbai Mar 22, 2009, 00:03 IST |
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How does gold exchange-traded funds (ETFs) function? Do they declare dividends? Could the price of gold ETFs rise and fall during a trading session like stocks?
- Shaileja Mammen
If you want to invest in gold, gold ETFs are a better option than physical gold. Gold ETFs are held in a demat account. This saves the investor from the hassle of storage and security.
Selling physical gold is a tedious task. When gold prices go up, there are few takers of physical gold. Banks do not buy back gold. Gold ETFs, on the other hand, are unit funds. They can be bought and sold like stocks on a real-time basis during trading hours.
Sellers of physical gold charge a commission. This can be as high as 5 per cent in the case of banks. Gold ETFs do not have any exit or entry load. The only charge is a small brokerage fee. Gold ETFs also have the assurance of the purity of the underlying gold. Physical gold purchase does not come with this assurance in most cases.
You can invest in as little as 0.5 gram of gold using gold ETFs. Further, investing in gold through ETFs gives tax advantages. The tax implications of physical gold is high. Gold ETF units held for more than one year qualify for long-term capital gains, whereas the holding period in physical form has to be three years to qualify for long-term capital gains. Also, gold held in paper form is not liable for wealth tax.
Most gold ETFs do not declare dividends, excepting for one asset management company (AMC) – Reliance Mutual Fund. The AMC does have a dividend plan, but it has not yet declared any dividend since its launch in November 2007.
At times, there can be a small disparity between the price of a gold ETF unit on the stock exchange and the price of the underlying asset. But it cannot be volatile like a share's price. ETFs are structured in such a way that large differences between their price and the value of the underlying asset does not exist for a long period of time.
If there is a huge increase in the demand or supply, creation unit holders step in to rectify the disparity. They buy and sell units till the mismatch is arrested. They can create or destroy units too.
The risk goes down as the number of funds increase. So, why is it advisable to invest in few funds? Is this advice suited only for systematic investment plan (SIP) or for lumpsum investments?
- Sonia
Increasing the number of funds is not a smart way of diversification. Ideally, five-six funds are sufficient to provide the diversification that one requires in the portfolio.
Increasing this number puts the investor at the risk of over-diversification. This also decreases the chances of a superior performance of the portfolio.
The increase in the number of funds also leads to repetition of stocks. And a large number of stocks are not at all necessary. What the investor requires is quality stocks. Also, as the number of funds increase, the allocation to quality stocks falls.
Apart from affecting the performance of your overall portfolio, a large number of funds will also face manageability issue. You will need to keep track of many funds, which is an unnecessary burden.
Few well-rated funds will provide adequate diversification and will also make the portfolio manageable by reducing paperwork. With this, you would also be able to closely monitor the performance of your funds.
This advice goes for one’s overall portfolio. It does not matter whether you are investing lumpsum or through SIP.
Does it make sense to invest small sums in every market decline (5 per cent or more)?
- Jojo Jacob
It would be great if one is astute enough to consistently buy at dips and sell at highs. But it is difficult to define a dip for this type of investment technique. Since January 2008, market has dipped and dipped further. If you would have made investments on every dip, you would still be sitting on losses. No one can time the market.
The way to make money from equities is to build a portfolio of good stocks and patiently hold it. And by good stocks, we mean stocks of businesses with sound management and the potential to burgeon their earnings. But this requires an investor’s time and inclination. The alternative is to buy a ready portfolio by way of a mutual fund and invest regularly in it. Also, SIP ensures discipline. This is the next best way to profit from equities.
I have put some money in a liquid fund and opted for dividend reinvestment option. What will be the tax implication? Is the taxation different for equity and liquid fund?
- Manoj Pruthi
Many investors opt for dividend option to reinvest the dividend. But they fail to realise that dividend is part of their investment that is coming back to them.
Opting for dividend reinvestment option would have saved them from the paper work associated with fresh purchases, which may also attract entry load. To save short-term capital gains tax, you will need to hold each of these individual investments for over a year.
In case of liquid funds, there will definitely be a tax liability on the capital appreciation. If you redeem the units within 365 days from the date of purchase, then any short-term gains would be added to your income and taxed as per your applicable slab. If the redemption is made after 365 days from the date of purchase one is liable to pay long-term capital gains tax. Dividends are irrelevant to capital gains tax.
The same principle applies to equity funds too. But the actual tax paid will be different. In case of equity (whether funds are shares) neither dividends nor long-term.
The tax on dividend is same for all funds. They attract dividend distribution tax (DDT).
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