Gold is back as the safe haven option in the minds of investors on the backdrop of the recent spate of volatility in the equity markets. However, should you go for it?
Purchasing gold, the ultimate symbol of prosperity and wealth, is an age-old tradition practiced on Akshaya Tritiya, as this is considered an auspicious day for new beginnings. Also, most of us believe that gold gives us an overnight liquidity in difficult times.
Economically also, gold is considered as an inflation hedge. The factors that drive gold prices are typically international gold rates, rupee dollar equation, inflation, interest rates, geo political factors and primarily global instability. The main reason in the past for a sharper gold rally was global recession. During the time of recession, people did not find safety in any other asset class. Hence, they preferred gold as an investment, which led to increase in gold prices.
However, is buying gold really a good idea from the investment standpoint?
First off, investing in gold is not the same as buying gold for consumption. If you plan to buy gold for your daughter’s wedding or to gift your wife, that shouldn’t be counted as investment. Jewelry has emotional value and people generally don’t wish to sell it except in times of extreme financial distress. In addition, making charges during purchase and breaking charges during sale make jewelry unattractive as a form of investment.
Is now a good time to invest in gold?
Gold is back as the safe haven option in the minds of investors on the backdrop of the recent spate of volatility in the equity markets. However, does the performance of gold and gold-backed financial products in the recent past back this belief? Before we look at the numbers, here is the fundamental reason why gold is not a great idea as a pure investment option.
As an asset, gold does not have earning power unlike other assets like equities, fixed deposits, or government bonds. Gold is an idle asset as it does not grow, compound, or provide any form of income. Any growth in the value of gold depends on the expectation that its demand will increase in the future. Hence, people invest in gold as they believe that they will be able to sell it at a higher price in the future. However, this is not always the case, as evident from performance figures in the table below.
Now, a quick look at the past performance of gold:
Why paper gold is a better alternative to physical gold
Of all the ways to invest in gold, physical gold is the most to be avoided as there are problems of safety and storage associated with it. People can store their physical gold in bank lockers, but this is at the cost of annual maintenance charges/fees. Another issue is liquidity. Not all sellers buy back gold; some dealers buy back only the gold coins that they have sold to you.
Gold ETFs and Gold Mutual Funds are better ways to invest in gold. Gold ETFs invest money pooled from investors in standard gold bullion. They track the domestic price of gold and the value of your investment moves in tandem with market prices of gold. Gold funds, on the other hand, invest in Gold ETFs and sometimes gold mining companies. Since these products are not physically stored, the worry of storage and theft is eliminated. Further, they are liquid as they are freely tradable. A demat account is required for investing in ETFs; this is not the case for gold mutual funds.
Sovereign gold bonds (SGBs) launched by the government are a new way of investing in gold. SGBs are issued in tranches in different times of the year and are sold by banks and post offices. The upside of SGBs is that investors will be paid an interest which is variable for each tranche (2-2.5% typically). Besides, the bonds enjoy capital gains tax exemption on the maturity proceeds; tax is to be paid only on interest earned every year. The buying and redemption price is linked to actual gold prices in the domestic market. The bonds have an 8-year maturity with an early exit option from year 5 onwards.
Focus on goals, not gold
Most people agree that the ultimate purpose of investments, whether gold or any other asset, is to meet goals. And from our experience as financial coaches, we find that goals are most likely to be met when there is a planned approach. We advise clients on the systematic method of identifying life goals, prioritizing, planning how much is to be saved and, (only) in the end, selecting assets and products to invest in. Goal-based investing works because setting a goal makes you emotionally invested in the process and makes you save diligently to meet the goal without being affected by market fluctuations.
If the purpose is consumption, then consider spacing out the jewelry purchase over a few months or quarters to average out the cost.
(By Amar Pandit, CFA, Founder of Happyness Factory)