Your Questions Answered: I want to invest in gold mutual funds. Please elaborate its pros and cons

Q. I run a small startup in the healthcare space out of Jaipur, I also help in my family’s pharmacy business. Our family has traditionally made most of our investment in fixed deposits and gold jewellery. Recently we have started investing in large-cap mutual funds too. However, we wish to invest in gold mutual funds too. However, we have limited knowledge of that field. Can you please throw light on the pros and cons of investing in gold mutual funds and the taxation of the investment made in gold mutual funds?

Jaivrat Singh Shekhhawat, Jaipur, Rajasthan

Investing in gold through gold coins and jewellery has been a custom in India. This is because gold has historically been seen as a safe haven during times of economic uncertainties. In the present day and age, mutual funds have become one of the most popular investment tools.

Through gold funds investors now have the opportunity to invest in gold without the problems associated with investing in physical gold like storage and security. These funds offer a convenient way to participate in the gold commodity market through a portfolio of gold-backed assets.

Gold mutual funds

Gold mutual funds are funds of funds, i.e., they invest the money they pool from investors into other underlying mutual fund schemes. In the case of gold mutual funds, they invest the money they have raised from investors into gold ETFs. Here it is important to understand, where these gold ETFs invest, to understand where the money pooled by gold mutual funds is invested.

Gold ETFs are mandated under Securities and Exchange Board of India (SEBI) regulations to invest only in physical gold and gold-related instruments that have been approved by the SEBI. Each unit issued by a gold ETF represents is issued against the gold held by them and the price of each unit replicates the movement of the gold on the metal exchange. Since gold mutual funds invest in gold ETFs, the investment made by an individual in a gold mutual fund will replicate the performance of gold in the commodity markets.

Pros of investing in gold mutual funds

Diversification: Gold mutual funds help you further diversify your portfolio as gold has historically often had a negative correlation with other asset classes such as investments made in shares, bitcoin, property, etc. As a result, gold has the potential to act as a defensive investment in times of economic or geo-political uncertainty.

Convenience: As discussed above, by investing in gold mutual funds investors can gain exposure to gold without being exposed to the problems associated with investing in gold through traditional means such as safety concerns, paying for making charges in case of jewellery, risk of adulteration, etc.

Liquidity: Units of gold mutual funds can be redeemed at any point in time, there is typically no lock-in period. Investors can get cash typically within a week of making a redemption request.

Lower costs: The expense ratio charged by the gold mutual funds on a yearly basis is much lower than the cost associated with purchasing physical gold in the form of jewellery. Purchasing units in gold mutual funds does not involve making charges, goods and services tax, or any other kind of tax or surcharge. Separately, no cost is incurred by the investors for safekeeping or on insurance for the units held.

Professional management: Gold mutual funds are managed by professional fund managers who have the expertise to navigate the complexities of the gold market. They make informed decisions on asset allocation and timing, aiming to maximise returns for investors.

Cons of investing in gold mutual funds

Underperformance: Gold has historically given returns lower than the large-cap indices such as Sensex and Nifty. This is especially true for the past 5-year performance.

Regulatory uncertainty: Gold prices have been impacted in the recent past because of a reduction in customs duty by the Indian government in the budget. Regulatory uncertainty can impact gold prices to a large extent.

Price fluctuation: The price of gold can be volatile in times of geopolitical uncertainties. Events like wars in far-off countries can have a significant impact on the price of gold in India. Gold mutual funds’ performance is directly impacted by fluctuations in the global gold market.

Performance of gold mutual funds

Most gold mutual funds have given a return of ~16% over the last year (absolute return), and have grown at a CAGR of ~12% over the last three years (CAGR return). Below we have mentioned the top 5 gold mutual funds (direct schemes) tracking the price of gold basis their 3-year return:

(Source: AMFI; data as of 6th August 2024)

Note: Past performance is not an indication of future returns.

It is important to mention here that gold prices have taken a severe hit in 2024 because of the lowering of customs duty on imported gold by the Indian government.

Further, federal banks around the world have increased their purchase of gold in the recent past. This is because of geopolitical uncertainties and the quest for financial security since gold is traditionally viewed as a safe-haven asset during times of economic instability. The perception of gold as a hedge against inflation and currency devaluation further cements its appeal in a de-dollarizing world. As the dollar's dominance in global markets wanes, gold's role as a store of value becomes increasingly prominent, potentially leading to a rise in its price as investors seek assets that can preserve their wealth

How to invest in gold mutual funds?

Investing in gold mutual funds is a straightforward and simple process. Investors can purchase units of gold mutual funds through various platforms, including online zero brokerage mutual fund investment platforms or directly through the websites of mutual fund houses. It is pertinent to consider factors such as expense ratio, and past returns before investing.

Taxation of investment made in gold mutual funds

Understanding the tax implications of any kind of investment is a crucial step in order to make an informed decision and for optimising returns. In the paragraphs below we provide a brief overview of the taxation rules that apply to investments in gold mutual funds.

How are gold mutual funds classified?

Gold mutual funds are classified as debt mutual funds and are taxed accordingly under the Indian tax regime. It is important to clarify here that they do not invest in debt instruments, however, for the purposes of taxation they are deemed to be classified as debt mutual funds. Under the Indian taxation regime not only gold but even mutual funds investing in foreign equity stocks are considered as debt mutual funds by creating a legislative fiction.

Union Budget 2024

The Union Budget 2024 (II) (Budget 2024) revised how gold mutual funds will be taxed and capital gains from gold mutual funds will be treated the same as those from debt mutual funds. Separately, indexation benefits have also been removed for such investments.

In conclusion, gold mutual funds present a convenient and modern solution for individuals looking to include gold in their investment portfolio. They offer the benefits of gold investment combined with the ease, flexibility, and convenience of mutual fund investing.

As with any kind of investment, it is crucial to conduct deep research and consider your financial goals and risk tolerance before making any kind of investment decision. Investors should take into account all the policy changes and fluctuations of gold prices in the global market because of geo-political events before they make any investment decision pertaining to gold mutual funds.

Disclaimer: Investing in mutual funds involves risks, including potential loss of principal. Please consult with a financial advisor before making any investment decisions.

Kuvera is a free direct mutual fund investing platform.