Sovereign Gold Bonds: An attractive tax-free wealth creation investment option

Sovereign Gold Bonds are an affordable, tax-saving investment option that’s ideal for risk-averse investors who seek steady returns in a volatile market.

Sovereign Gold Bonds: An attractive tax-free wealth creation investment option

Indians have always had a cultural affinity for gold. Wisdom passed down through generations has conditioned us to invest in gold, which is expected to come in handy on the proverbial rainy day. It is also considered auspicious to buy gold around the time of festivals such as Dhanteras. 

As the world’s largest importer of gold, India’s annual demand for the precious metal is in the order of 900 million tonnes. This voracious appetite cost the economy USD 11.45 billion in April–July 2019, as against USD 8.45 billion for the same period the previous year.

In 2015, the government launched the Sovereign Gold Bond (SGB) scheme to control foreign exchange outflows and reduce the widening current account deficit. The aim was to harness the demand for gold in order to boost public savings, thereby reducing external debt.

Related: 8 Key differences between bonds and debentures 

What are Sovereign Gold Bonds?

Sovereign Gold Bonds (SGBs) are securities issued by the Government of India in lieu of gold units purchased by investors. Unlike physical gold, bonds can be bought in paper or digitised demat form. The scheme is not available for subscription throughout the year; the bonds are issued in staggered monthly tranches based on a schedule announced by the RBI. The last of a series of six tranches as part of the SGB scheme 2019-20 was issued between March 2 and March 6, 2020, at INR 4210 per gm.

Units may be purchased in denominations starting from 1gm. During a given financial year, an individual investor may buy no more than 500gm. The government has specified a maximum limit of 4kg for investors choosing to buy on an individual basis or jointly with family members as in the case of the Hindu Undivided Family (HUF). However, in case of joint ownership, the 4kg limit only applies to the first buyer. Another distinct feature of SGBs is that institutional investors such as trusts and universities can buy gold units up to a maximum limit of 20kg.

The current rate of interest offered on Sovereign Gold Bonds is 2.75% and is paid out twice a year. At maturity, investors get a lump sum based on the prevailing market value of the units they hold, in addition to interest. The market value on the date of redemption is calculated as a simple average of the closing price of 24k gold, for the previous three consecutive days. This rate is determined as per the data published by the Indian Bullion and Jewellers Association. 

Sovereign Gold Bonds have a tenure of eight years, but investors can choose to exit on completion of the lock-in period of five years. They can also be traded in the secondary market or gifted to others, depending on the fulfilment of certain eligibility conditions (explained further below).

Related: 6 Situations in which a gold loan can come in handy

What are the benefits of investing in SGBs?

Investing in gold bonds can help investors diversify their portfolios and hedge against volatility in the equity market. Since returns are guaranteed by the government, investing in Sovereign Gold Bonds is completely risk-free. Here are some key reasons why SGBs are a good bet:

1. Non-physical nature: Sovereign Gold Bonds do away with worries about the security or purity of physical gold. As the name suggests, the central government undertakes to honour transactions under the SGB scheme. It issues a certificate of holding to this effect at the point of purchase.

2. Collateral option: Sovereign Gold Bonds can be pledged as collateral to banks and other financial institutions by investors to avail of credit. However, this is subject to the rules and regulations of individual lenders and cannot be enforced by the government as the issuer.

3. Tax benefits: Interest from SGBs is exempt from capital gains tax, making them ideal tax-saving investments for individuals who fall in the 30% tax bracket. However, this is only possible if the SGBs are not redeemed or sold prior to maturity. The trade-off between returns and tax liability is favourable as Sovereign Gold Bonds can be collateralised if needed.

4. Zero expense ratio: In this time of growing expense ratios or fund management fees, SGBs offer investors complete relief from having to forgo a part of their earnings for administrative expenses. This means better returns on investment for every rupee invested.

5. Discounts on purchase price: As a rule, the face value of a Sovereign Gold Bond unit is discounted by INR 50 on the prevailing market rate for online buyers. If you have a long-term investment horizon, this may be the best time to invest in SGBs. The reason: the SGB scheme is a long-term investment option and consequently cannot be liquidated easily.

Related: Gold ETFs vs Physical gold: Which one is better? 

What are the drawbacks of investing in SGBs?

Now, let us look at the disadvantages of investing in Sovereign Gold Bonds.

1. Poor liquidity: As discussed, the lack of liquidity is one of the chief reasons why Sovereign Gold Bonds are not preferred by the majority of investors. If you choose to buy from the secondary market, you can redeem the bond units faster, but they will have to be bought at market value.

2. Fluctuating prices: The price for each issue or tranche may vary year-on-year as they are decided by the government based on demand-supply dynamics. Geopolitical factors can also cause a sharp rise in the price of gold and consequently influence the SGB price. So, timing the SGB market is virtually impossible.

3. Selling at a discount: While you may be able to buy Sovereign Gold Bonds at a bargain price, the average for it in the secondary market may also impact your prospects of getting good returns. If you do not want to wait till maturity, you may have to sell at below the market price, leaving no possibility of any tax-saving.

4. No compounding of interest: SGBs do not offer investors compounded returns, limiting their potential earnings. Investors may feel they were not rewarded adequately for staying invested over the eight-year tenure, especially if the prevailing gold price at the time of maturity remain close to the purchase price.

Related: Different ways to buy and invest in gold

How does one invest in SGBs?

Application forms are available with designated distributors such as public sector and private sector banks, designated stock exchanges, and post offices, in addition to the Stock Holding Corporation of India. You can also apply online after downloading the application form from the RBI website. Alternatively, you can opt to apply on the SGB portal of any authorised bank.

SGBs can be paid for in a number of ways: cash, cheque, demand draft, or online transfer. Approval is not automatic and depends on the fulfilment of certain eligibility criteria.

What are the eligibility requirements?

  • Only resident Indians with a valid PAN are eligible to apply for Sovereign Gold Bonds.
  • In case the applicant is a minor, the SGB can be issued to the parent.
  • Joint applicants – including trusts, universities, and associates – are eligible, provided they are registered in India.
  • One is required to provide identity proof and complete KYC verification as part of the application process.

Which is better: ETFs or SGBs?

Buying physical gold can be an expensive proposition. Gold Exchange Traded Funds (ETFs) offer a low-cost alternative to investing in gold, which can be traded via a trading and demat account. Unlike GSBs, there’s no restriction on the maximum number of gold ETF units that can be purchased. The risk of theft is substantially reduced with ETFs.

The biggest drawback of gold ETFs is that long-term capital gains (LTCG) tax is applicable at 20%, after indexation, beyond three years after the date of purchase. ETFs also have an expense ratio of up to 1%.

In contrast, Sovereign Gold Bonds are issued by the RBI on behalf of the government. As such, there are no administrative expenses to be borne by the applicant. Capital gains tax is not applicable in the case of SGBs, but they are relatively more illiquid and have a fixed rate of interest.

Related: What is the difference between E-gold and gold ETFs?

Last words

Sovereign Gold Bonds are an important step towards transforming India’s penchant for the consumption of gold into investing in gold. They allow the mobilisation of public savings to boost investment in the critical sectors of the economy, thereby increasing job opportunities. This, in turn, can contribute to higher per capita income for citizens, fuelling demand for the yellow metal.

Investing in Sovereign Gold Bonds should be a well-thought-out step, depending on one’s overall asset allocation and life goals. A diversified investment portfolio with a judicious mix of equity and debt, complemented by SGBs, can deliver above-average returns over a period of time. Here are some simple ways to check gold price before you buy.