If the cost of investing in a gold mutual fund is higher than a gold ETF, why do investors invest in gold mutual funds?
Gold mutual funds are open-ended investment products that invest in Gold Exchange Traded Funds, and their net asset value (NAV) is linked to the underlying ETF’s performance. Gold ETFs invest their corpus in gold bullion of 99.5 per cent purity to earn a return over it. As such, there’s an indirect link between gold mutual funds and the gold prices. Any fluctuation in gold prices impacts the gold ETFs, which, in turn, impact the NAVs of the gold mutual funds. Gold ETFs hold physical gold as an underlying asset, and it has to pay the carrying cost.
Gold mutual funds also carry charges that are reflected in their expense ratios, while some funds also levy an exit load. Usually, the expense ratio and charges in gold mutual funds are higher than the cost involved in gold ETFs. So you may be wondering, if the cost of investing in a gold mutual fund is higher than a gold ETF, why do investors invest in gold mutual funds? Let’s find out the answer.
Gold mutual funds vs. gold ETFs
It’s easier to invest in gold mutual funds in comparison to gold ETFs. You can invest in gold mutual funds directly through online mode or their distributors. On the other hand, you need to have a demat account to invest in gold ETFs. In a gold mutual fund, the AMC invests the corpus in gold ETFs to generate returns.
Also, gold mutual funds allow investors to invest through the SIP mode, but this facility is not available with gold ETFs. Gold mutual funds allow you to buy gold in fragments, and its value is presented in NAVs. So, instead of investing in grams of gold, you invest in terms of rupees in the gold mutual funds, whereas gold ETFs usually allow a minimum investment of 1 gram of gold. If you are looking for a systematic investment option, don’t want to open a demat account or want your investments in gold to be professionally managed by a fund manager, you might find gold mutual funds to be a highly attractive investment option.
It will be worthwhile to note here that there’s another digital gold investment option available, the Reserve Bank of India-backed Sovereign Gold Bonds (SGBs) that offer a 2.5% p.a. interest over and above the actual price of gold on the day of maturity, and there is no capital gains tax on redemption. However, SGBs do not offer the SIP option like gold mutual funds. Plus, gold mutual funds are more liquid than SGBs as the latter comes with a maturity tenure of 8 years. That being said, gold mutual funds, gold ETFs and SGBs are digital investment options that do not carry purity and safety concerns and charges like physical gold investments.
Things you must consider if you want to invest in gold mutual funds
Investments in gold mutual funds for more than 3 years are regarded as long-term and the gains thereof are called long-term capital gains (LTCG). The LTCG on gold is taxed at a 20% rate with indexation benefit (plus surcharge, if any, and cess), whereas short-term capital gains (STCG) are taxed as per the slab rate applicable to the investor.
Gold should be used as a tool to diversify your investment portfolio. In the long-term, gold can provide stability to your portfolio. You can start investing in gold mutual funds with as low as Rs 1000 through a monthly SIP.
Now, many companies are offering gold mutual fund products and you should select the best one based on some key factors. Look at the level of returns that the mutual fund company has provided in comparison to physical gold. If the returns are similar or higher, it may show the efficiency of the AMC. Also, check the average returns generated by other gold mutual funds and check the expense ratio of the shortlisted gold funds because the low expense ratio might allow you to earn higher returns.
Gold usually performs well whenever uncertainties grip the markets, like during the 2008-2011 global financial crisis and again during the ongoing Covid-19 turmoil. In fact, the prices of the yellow metal have increased by 25% since March 2020. However, it’s also a fact that since these risks are not of a permanent nature, the gold prices also tend to flat-line over long periods of time. So, it might be a good idea to use it as a hedging tool and limit your gold investments to a maximum 10% of your total investment portfolio’s value.
However, your investments in gold mutual funds should also be dynamic, i.e. you might want to stay invested in gold during high-risk phases, but when the risk starts fading away, you should consider reducing your exposure in gold and shift towards better-performing asset classes.
(The writer is CEO, BankBazaar.com)