Should Young Investors Invest in Gold and the Best Way to Invest in Gold

Indians have already had an obsession with gold. Families consider it as a valuable asset for times of crisis. However, how does it fare as an investment option for your financial goals? How much should you invest in gold, and which is the best way to invest? This article explores all these points and explains how you can use gold smartly for your financial planning needs.

Unique features of gold as an asset class

Before moving forward, let us understand the features, returns, volatility, and related aspects of gold.

Like equity, debt, and real estate, gold is like a separate asset class in itself. The reason is that gold has a very low correlation with equity and debt. Historically gold prices have moved opposite to equity prices. And that makes it in small amounts an excellent risk reduction in the portfolio.

Speaking of risk, don’t think of gold as a risk-free asset. It is not. In fact, it is equally or even more volatile at times, as equity. There can be long periods of flat returns or periods of sharp ups or dips as per the geopolitical situation. In the short term (periods of 3 years or less), gold has even given negative returns. Overall, long-term returns can be in the range of 5-10%, primarily aligned to the inflation rate.

Gold does not have any intrinsic value. It depends on the perception of the economy and geopolitical situation. Suppose there is a war or a health crisis like we have right now. In such a scenario, gold prices will increase substantially. However, the prices can remain completely flat (sometimes for years on a row) in a stable economy and peaceful geopolitical situation.

Gold does not generate any income. You earn only through capital appreciation, unlike equity shares that give regular dividend or fixed deposits or bonds, giving out a fixed coupon rate of interest.

Should you invest in gold?

Hope the above context helps you conclude that gold cannot help you in wealth creation and is not an investment in the truest sense. Its value lies only in its being a diversification tool. Some amount of gold (5-10% max.) can act as a cushion and help you reduce the risk of your portfolio as a whole. Gold has also proven to be a strong hedge against inflation. Historically, it has earned a return close to inflation over long periods.

In light of the above, you can have some suggestions for gold investment as follows:

  • Hold not more than 5-10% of the investment portfolio in gold, that too only for reducing risk and not for earning returns.
  • Please remember that gold is volatile in short durations. Gold exposure should thus be taken for only long-term financial goals. For short term goals (i.e., those coming up in the next 5 years), it is better to stick to pure fixed income options only
  • Suppose you have an existing portfolio and want to take gold exposure. In that case, you can leave the fixed income component intact and move some equity components to gold. Be aware of the tax implications.
  • Do not consider family gold as part of your investment portfolio.

Which is the best way to invest in gold

Previously, you could buy gold only in physical form, i.e., jewelry or bars and coins. However, with the development of the financial industry, you can now buy gold in paper form. Given the cost of storage and concerns of liquidity and purity of the physical gold, we highly recommend that you invest in gold through the paper route. You can invest in gold in paper form through the following ways:

  • Sovereign Gold Bonds (SGB)
  • Gold Exchange Traded Funds (ETFs)
  • Gold Mutual Funds (GMF)
    Some pointers regarding the best way to invest in gold are as follows:

  • If you invest in the long term and hold the gold investment until its maturity (i.e., 8 years), investing in SGB can be the best choice. The reason is that capital gains are tax-free if you hold them till maturity. Also, you get an additional income by way of interest (~ 2.5%). The interest is taxable every year. The only downside is that you can only buy these bonds in the primary market. Also, it is not easy to sell them midway, and capital gain will also become taxable.
  • If you are not sure of staying invested for 8 years at a stretch or want to make some short, tactical calls based on price trends, you can go for ETF or GMF. Prefer direct plans of GMF.
  • For regular monthly SIP as part of your investment plan, you can start a SIP in any good gold fund.
  • Suppose you need physical gold at a later stage, for example, as part of the wedding. In that case, a better approach than buying physical gold is to continue investing for the wedding goal in set asset allocation. You can liquidate the portfolio to buy gold as and when the need arises.

Conclusion

Gold is a valuable asset that can come to the rescue in bad times. Contrary to the popular notion, gold is not an investment in the truest sense and has a limited utility in the form of reducing risk in your portfolio. Hence it is essential to not go overboard on gold and invest in it for the right reasons. Also, it is helpful to explore investing in paper gold which is a much more efficient way of investing, which comes with less hassle and lower costs.

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