Dhanteras 2023: This Diwali, learn a new way to buy gold and start saving for your next purchase of yellow metal

In case you are planning to buy gold or start saving to buy gold for the next Dhanteras, this note will be very useful. It provides you with a potentially more cost effective alternative.

Gold Savings Scheme

Most of you may have heard of gold savings schemes run by almost all jewelers where the customer has to pay installments over several months and the jeweler pays one installment (or part of it). At the end of the tenure, customers can purchase gold/jewellery with the amount accumulated in the scheme at the prevailing gold prices. This is a good scheme in a way that helps customers

⦁ Develop a savings habit by saving periodically.

⦁ Earn the periodic amount through jeweler contribution.

⦁ Create an asset in the form of gold at the end of tenure.

An example of such a scheme from one of the jewellers:

So what’s the catch here? Are there any risks involved? We need to look holistically:

1) Counterparty Risk – One of the most important risks that customers forget about here is credit risk. What happens if the jeweler goes bankrupt? A jeweler has no guarantee or collateral of gold when customers subscribe to such schemes. In India, many jewelers (even the big chains) have gone bankrupt and consequently many customers who subscribe to such schemes have been left stranded.

2) Gold price risk – What happens if the price of gold rises at the end of the tenure? In gold saving schemes, customers do not benefit from a rise in the price of gold despite paying periodic installments. In fact, many times customers end up buying gold at a higher price at the end of the scheme tenure.

3) Ancillary cost – The gold price quoted by a jeweler is higher than the actual gold price and also varies from jeweler to jeweler. This is due to various ancillary cost components that are added to the cost of the actual gold price. This includes the jeweller’s markup on the price of gold, GST on gold @ 3% and charging charges depending on the type of gold purchased.

The price quoted by top jewelers for 24 carat gold coins was ~11% higher than the normal gold price based on data as on November 07, 2023. Since customers have to buy gold from the same jeweler under the scheme, there will be no he has no choice but to accept the price quoted by the jeweller.

An illustration of the variation of the gold price as of November 07, 2023

* this is only an indicative range obtained from multiple websites and public disclosures.

4) Sell price mark up – The buying price of gold is usually lower than the selling price for jewelers. Accordingly, customers must also bear this cost at the time of liquidation of their gold. Also, there is wastage/loss in the case of jewelery which also affects the selling price.

How can SIP in Gold ETF & Gold Fund of Fund be a better alternative to jewelery gold savings scheme?

Counterparty risk:

First, let’s understand what Gold ETF & Gold Fund of Funds are. Gold ETFs are mutual fund schemes that invest in physical gold of 999 purity, the units of which are listed on the stock exchange for buying and selling. An investor must have a demand account to invest in Gold ETFs. Gold ETF FoF is a mutual fund scheme that invests in Gold ETFs & an investor can invest in the fund like any other mutual fund without the need to have a neat account. Physical gold is kept in safe custody in a vault with insurance in place. Therefore, Gold ETF & Gold ETF FoF are backed by physical gold, which has no counterparty risk.

Pricing:

Gold ETF & Gold ETF FoF valuations are directly linked to the actual domestic price of physical gold. There will be no mark-up or any demanding fees. In addition, GST paid on the purchase of gold can be used to set off against GST collected at the time of sale. This is reflected in the NAV of the fund and accordingly the investor gets the benefits. However, the investor must bear an expense ratio of the ETF/fund which can be up to 1% per year. This is still very low compared to the 11% premium paid. Therefore, investors save additional markup, charging fees and other ancillary costs if he/she invests in Gold ETF or Gold ETF FoF.

Gold price movement:

An investor receives units for each installment based on the prevailing gold prices on that date. Hence, investors can benefit from rising gold prices in the ETF/Fund as reflected in the NAV of the fund.

Interpretation – Which is better to use historical evidence?

Let us compare 2 investment scenarios.

⦁ Make a 12 month installment in a jeweler’s gold savings scheme with a jeweler making the 13th installment. A gold coin with the accumulated amount is bought at ~10% higher value from a jeweler.

⦁ Do a 12-month SIP in Gold ETF FoF with an expense ratio of 1% (max).

Result –

⦁ 81% of the time investors get better returns in gold savings scheme Gold ETF FoF vs jeweler

⦁ 75% of the times an investor would have made positive returns from SIP in Gold ETF FoF

⦁ Average overall results are ~7%

Some disadvantages of a Gold ETF or FoF over a jeweller’s gold savings scheme

⦁ The most important shortcoming of Gold ETF or Gold ETF FoF is that it is tax inefficient. The investor must pay tax according to the maximum tax rate based on his/her slab rate on gains in Gold ETF/Gold ETF FoF. In the case of a gain in physical gold purchased from a jeweller, an investor can benefit from a lower rate of taxation on long-term capital gains.

⦁ Gold ETF/FoF is a good alternative to buying physical gold coin/gold bars to seek gold exposure. Where an investor intends to buy jewellery, a gold ETF or FoF may have a limited use case.

In summary, Gold ETF or Gold ETF FoF can be a better way to take exposure to gold as it can help investors save on ancillary cost like making charges, mark-up, storage cost, etc. It is backed by physical gold of 999 purity ( 24 carat) & prices linked to actual domestic gold prices. However, the investor must note that although gains are not tax efficient compared to physical gold, it still makes sense in terms of returns and removes many of the risks associated with owning gold in the form of physical.

The author, Devang Chawda, is Product Manager, DSP Mutual Fund.

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Updated: 10 November 2023, 07:06 PM IST