2.5% interest, tax exemption on maturity make gold bonds attractive

But there's a lock-in of five years and investors lose tax exemption if they exit prior to maturity

The first tranche of sovereign gold bonds (SGBs) matures on November 30. Investors who have held them until maturity will earn good returns from these bonds.

“This first tranche will generate a 10.88 per cent compounded annual growth rate (CAGR). Along with the 2.75 per cent per annum interest payable semi-annually on this tranche, the CAGR would be 12.54 per cent before tax and 11.95 per cent after tax for anyone in the 30 per cent tax bracket,” says Jigar Patel, member, the Association of Registered Investment Advisors (ARIA).

Understand the pros and cons of SGBs before rushing to invest in them based on past returns.

2.5 per cent interest kicker

SGBs are dematerialised, so they don’t entail any storage or security concerns.

Says Col. Sanjeev Govila (retd), Chief Executive Officer (CEO) of Hum Fauji Initiatives: “Their maturity value is linked to gold’s market price. An investor also gets 2.5 per cent interest (reduced from 2.75 per cent earlier) per annum payable semi-annually, which no other gold instrument offers.”

Those who stay invested for the entire tenure of eight years get tax benefits. “Interest is taxable at slab rate but capital gains are exempt if held till maturity," says Maneet Pal Singh, partner, I P Pasricha & Co.

Beware of liquidity issues

Liquidity is low in SGBs. There is a lock-in period of five years. After five years, one can redeem SGBs. This can be done twice a year—on the coupon payment dates.

One also has the option to exit SGBs anytime by selling them on the exchanges. “While SGBs are considered liquid as they can be traded on the exchanges, the investor may not get a fair price (due to low liquidity). He would also lose the tax exemption on capital gain if he sells prior to maturity,” says Patel.

Singh noted that the long-term capital gain on SGB would be taxed at a flat 10 per cent without indexation benefit or 20 per cent with indexation benefit (if sold before maturity).

Govila says that investors who require liquidity can also take a loan from various banks and non-banking financial companies (NBFCs).

The return on SGBs is not guaranteed: it depends on the market price of gold prevailing at the time of maturity or sale. Investors should also not overlook the possibility of capital losses.

“Remember that the investor is exposed to the risk of capital loss owing to gold price movement,” says Deepali Sen, founder and partner, Srujan Financial Advisers.

Gold ETFs are more liquid

SGB beats physical gold on all parameters.

“In SGBs, there are no holding costs, no making charges, and no purity issues,” says Sen.

Gold exchange-traded funds (ETFs) invest in 99.5 per cent pure gold sourced from RBI-approved banks. Gold mutual funds invest in gold ETF units.

“ETFs are more liquid. One can buy any number of ETFs but can only buy a maximum of 4 kilograms of SGBs every year. However, unlike SGBs, ETFs do not pay interest. Hindu Undivided Families (HUFs) cannot buy ETFs but they can buy SGBs,” says Sen.

Investors also pay an expense ratio in ETFs and gold funds.

Take the plunge

Finally, who should invest in SGBs?

Says Mrin Agarwal, founder and director, Finsafe India: “Anybody who wants to allocate to gold should do so through SGBs provided they have an eight-year horizon.”
 

Govila points out that fresh issuances may not be available in the near future. “The government has not announced any more SGB issuances for 2023 (there were two this year in June and September). The schedule for 2024 is also not known. Those who do not wish to wait can invest in SGBs available in the secondary market whenever gold’s price corrects,” he said.
 

According to Patel, while SGBs will always outperform gold ETFs and funds on an after-tax basis because of the 2.5-2.75 per cent interest and capital gain exemption benefit on maturity, investors not sure about being able to hold SGBs until maturity may opt for gold ETFs or funds.