21 Apr 2014

All That Glitters Is Not Gold!

Us Indians have an involved relationship with gold. Gold is considered auspicious, pretty, is an investment and and is supposed to provide security to any portfolio. Our weddings are dazzled with the amount of gold displayed in the form of jewellery and ornaments. Not just women, but men also wear gold jewellery in one form or another.

Confession -
I have never been attracted to gold as jewellery. My mother says that I will start appreciating the value and beauty of gold once I reach a certain age. I have to say - I find gold jewellery prettier now than when I was in my twenties. I think gold jewellery can be very artistic but I question whether it is worth the expenditure. I hardly wear gold. I enjoy wearing jewellery, just not gold jewellery. Even though I have pretty pieces of gold jewellery, I do not think that wearing it is a status symbol. In fact, I look at gold jewellery as a responsibility. I have to take care of it and be careful not to lose it. If my opinion changes, I will be sure to let you guys know!

Gold was considered the prime liquid instrument and till today people look at it as a secure investment. Gold prices have risen manifold in the past twenty years and those who invested in it two decades ago are bearing the fruit of their investment. The traditional way of investing in gold was through jewellery or gold bars. Jewellery has the problem of making charges. Both jewellery and gold bars have the issue of safety, arranging a safe deposit locker at the bank to protect it and having different buying and selling rates. This is the reason financial advisers recommend gold ETFs and gold funds. What are gold ETFs and gold funds?

Gold ETF's - Gold Exchange Traded Funds
These are exchange traded funds which one buys and sells through a Demat account. One unit of a gold ETF equals 1 gram of gold. The returns on ETF's are higher than a mutual fund but buying and selling does have a commission involved. Most Demat accounts also have an annual charge.

Gold Funds
This is a mutual fund which invests in a gold ETF. The returns are slightly lower than an ETF. The expense ration is also lower than the commission of an ETF.A demat account is not needed.

Physical Gold vs. Gold ETFs vs. Gold Mutual Funds

Physical gold has the longest history in the Indian economy. Buying and selling gold after holding on to it has yielded 20% on average year after year over the last two decades. However, it poses risks of theft and making charges. Moreover, buying gold is adversely affecting our economy. It is the reason, gold ETF's and mutual funds were released.

Gold ETF's have a longer history in the Indian economy as compared to gold funds. I looked at fundsindia.com and most gold ETFs have been around for more than six years. You will need a demat account but the returns look fairly good since 2008. As with any ETF, there are no guarantees as to what it will yield in the future.

Gold funds have the shortest history. To gather data, I looked at the gold funds available on fundsindia.com. Some have a 3 year history and most have less than a 3 year history. Gold funds provide the convenience of being bought without a Demat account.

Which one should I buy? - Physical Gold, Gold ETF or Gold Mutual Funds

My vote is for Gold ETFs or gold funds. ETF's have had longer history and do not have the problem of storage, safety and making charges. Gold funds should closely resemble the returns of the ETF since they are comprised mainly of the ETF. E.g. Kotak gold fund is 99.01% Kotak gold ETF and Reliance gold fund is 99% Reliance ETF. If you find ETFs complicated because of brokerage and the chase for buying and selling, opt for funds.  I would avoid physical gold because of the drawbacks discussed.

Should gold be a part of my portfolio at all?
Most financial advisers recommend that investments in gold should not exceed 5 to 10% of your portfolio. I am not clear about how the numbers came about. Gold prices are independent of the stock market which is why it is good to have a little bit of gold in your portfolio. However there have been economic depressions in the world when gold was not considered worth anything at all.E.g. The Great Depression of 1920 in the U.S where money and gold became worthless and people adopted the barter system - exchanging goods someone else needs for the ones that they required.  However, advisers say that investing in elements is not like investing in stocks since it does not generate goods and services and prices of gold are simply decided by demand and supply. I agree that gold does not generate goods and services but price of anything is determined by demand and supply. I guess the advise out there is not to over-invest in gold like our earlier generations did.

There are plenty of people I know who choose not to invest in gold or invest very little in gold. The flip side of a portfolio which is gold heavy also exists. You will have to decide your investment strategy but please do it logically. Gold is something that people get attached to. We should not get attached to our investments. We should be detached and yet not indifferent.

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