What is gold ETF?
A gold Exchange Traded Fund (ETF) is an investment option that tracks domestic gold prices. A single gold ETF fund unit will be equal to 1 gram of gold.
In general, ETFs can track different equity indices like S&P BSE Sensex, NSE Nifty50, debt indices like State Development Loans (SDL) Indices, commodity prices like gold, etc. Gold ETF fund as an investment product generates returns for the investors based on the prices of physical gold. Whenever an investor puts some money in a gold ETF fund, it is invested by the fund house in physical gold bars/bullion. Any changes in the value of the physical gold are directly passed to the investment portfolio valuation of the physical gold. This is because gold ETF share price depends on the physical gold price in real time.
Thus, the investors have a simplified method for investment exposure to the yellow metal through gold ETF funds. They can buy and sell ETF units during the exchange trading hours in real-time. They can check gold ETF funds and gold ETF share prices online on BSE/NSE websites, to make a sound investment in gold.
How do gold ETFs work?
Gold ETFs are like other mutual funds. The major difference is that mutual funds create a portfolio of different equity and debt securities, while gold ETFs will only have physical gold in the portfolio. Here is how a gold ETF typically works:
1. Creation of ETF units – The mutual fund creates gold ETF units with physical gold as the underlying investment. These units are listed on stock exchanges for buying and selling by investors. Gold ETF prices will keep changing according to the domestic gold prices.
2. Trading ETF units through stock exchanges - You may invest in gold ETF funds by putting buy/ sell orders for ETF units through the stock trading account. The units will be credited/debited to/from your Demat account, just like a typical stock.
3. Valuation changes of ETF units – Since the underlying investment for ETF units is physical gold, any changes in the gold value will drive the changes in the NAV of the gold ETF fund and the gold ETF price. However, there may be some variation due to demand and supply of gold ETF units on the exchange, demand and supply of physical gold in the market and cost.
Benefits of gold ETFs
Defensive investment option
Gold is generally considered as a defensive investment option, which not only hedges against inflation but also favoured during the times of risk-off sentiments. As recently as March 2022, gold has seen sharp rallies as the geopolitical tensions intensified across Asia- Europe region. It makes sense to make partial allocation of the investment portfolio in gold. Gold ETFs being in nature of digital investments make it easier and convenient to make such allocation. ETF units are traded in digital form through the Demat account. As such, the investors do not have to worry about the storage & safety of the gold investment. In contrast, in case of physical gold, one often needs bank locker or safe wallets for safe custody of the valuable asset.
Elimination of risk of impure gold
The underlying investment in physical gold is made only in the internationally acceptable hallmarked gold and with minimum fineness (or purity) of 995 parts per 1000 (99.5%). Further, investors get the investment valuation as per the benchmark and thus, they need not worry about the quality unlike investing in physical gold. In case of physical gold, the investment value’s risk may be at the behest of the jeweller, from whom one is buying gold.
Price similarity
Gold ETFs are traded on the exchanges on a real-time basis. Hence one may invest or liquidate the investment at prevailing trading prices irrespective of geographical location differences. In the case of physical gold, prices may vary from city to city, or even jeweller to jeweller even in the same city or area, considering making charges.
Cost-effective manner of investing in gold
Since gold ETF NAV moves in line with the movements in benchmark gold prices, it may be considered an alternative to physical gold investment. Further, investors do not need to incur additional costs, e.g., quality inspection charges, minting/making charges, locker charges for the safe custody of gold, etc. They may monitor the investments directly through their Demat account.
Exit load
Unlike several mutual fund schemes, there are no exit load implications even if the investor wants to liquidate the investments shortly after making an investment. However, there may be certain other charges applicable, such as brokerage charges.
Higher liquidity
Gold ETFs are listed on national stock exchanges, and the investors may manage to sell their investment in Gold ETFs by placing a sell trade through their trading accounts. Once the order is executed, the sale proceeds are credited to the Demat account in a time-bound manner as per the settlement cycles of the stock exchange. Further, investors may stay updated about their investment in Gold ETF by checking the real-time valuation of the ETF units on the stock exchanges’ website.
Tips on investing in gold ETFs
1. Average daily turnover
The liquidity of ETF units on stock exchanges is a crucial parameter for an investor. In the absence of sufficient daily turnover, an investor may not be able to sell the gold ETF units at market prices. Investors may have to sell units at lower prices to generate sufficient demand. This difference between the market value and the transaction value is referred to as the impact cost. 2.
2. Total Expense Ratio (TER)
Since scheme expenses are charged on ETF returns, a higher expense ratio directly impacts investor returns. As such, in the case of two Gold ETFs tracking same benchmark price for gold, the returns of the fund with higher TER will be lower. Thus, one may prefer investing in a gold ETF with lower TER.
How to sell / redeem gold ETF?
One can invest or sell gold ETFs in the same manner as they do for stocks. If one needs to sell/redeem gold ETF units, a sell order must be entered for the units through the Demat trading account. The order must specify the number of ETF units being offered to sell and the price at which the investor is offering to sell. The order may be a market order or limit order. A market order means that the order would be executed at whatever the prevailing market price is. In contrast, a limit order specifies the minimum selling price at which the investor is willing to sell their gold ETF units. In case the market price reaches the specified limit price, the order is executed. However, if the specified limit price is not reached, the order is cancelled at day end and the investor may need to place another order on the next trading day, if required. The ETF units will be debited from Demat account, just like normal stocks.
Comparison of gold ETFs vs gold bars vs jewellery
| Particulars | Gold ETFs | Gold bars | Jewellery |
|---|---|---|---|
| Charges and transaction costs | Cost-effective as transaction costs are pre-determined and minimal | Minting and wastage charges make up a higher proportion, thereby lowering the effective investment in gold | Making and wastage charges make up a higher proportion, thereby lowering the effective investment in gold |
| Safety of investment | Investment held in digital Demat account and thus, secure | Arrangements must be made for safe custody like bank lockers/ safe wallets, etc. | Arrangements must be made for safe custody like bank lockers/ safe wallets, etc. |
| Quality concerns | No concerns on quality of investments, as the investor makes investment in digital form | Quality of gold has to be verified to ensure proper value for the invested amount | Quality of gold has to be verified to ensure proper value for the invested amount |
| Convenience to invest | Most convenient, as the investment can be made online | Investment needs to be made through city jewellers/ trading houses etc. | Investment needs to be made through city jewellers/ trading houses etc. |
| Transaction price | Transparent and real-time pricing through stock exchanges | Pricing may be different from city to city and from jeweller to jeweller | Pricing may be different from city to city and from jeweller to jeweller |
Why invest in gold ETF?
Portfolio diversification across the asset classes helps in long-term wealth creation. Further, gold generally tends to have a negative correlation with the stock markets and is usually considered to be safe. It has served as a hedge against inflation and may further absorb the market corrections to provide stability to the portfolio. As such, it makes sense to diversify through investment in gold.
Gold ETFs are thus preferrable for such investors who are looking to invest in gold for investment and portfolio diversification. It is a simpler option for making an investment in gold without worrying about the safety and quality of the yellow metal. Additionally, it is convenient to invest in gold ETFs sitting at the comfort of one’s home, as the investments are done online through stock exchanges.
However, with a wide range of investment options available for investment in debt and equity, the allocation of gold should not generally exceed 10% of the total portfolio.