What is a Gold ETF? A Complete Guide for Investors

What is a Gold ETF? Meaning, Benefits, and How It Works

Buying physical gold is not the only way to leverage its wealth-creation potential. In fact, there are several smarter alternatives that remove the hassle of storage and purity checks. One such instrument is the gold Exchange Traded Fund (ETF). 

If you are wondering what a gold ETF is, this comprehensive guide can help you understand the financial instrument. It combines the flexibility of stock investments with the simplicity of gold investments.

What is a Gold ETF?

A gold ETF is a type of mutual fund that tracks the price of physical gold. When you buy a unit of a Gold ETF, you are indirectly buying a corresponding quantity of physical gold without holding the metal yourself.

Every unit of a gold ETF represents one gram of gold with 99.5% purity. Unlike regular mutual funds, the units of ETFs are listed on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). You can purchase and sell them in real-time during market hours just like the shares of a company.

How a Gold ETF Works?

Now that you know the meaning of gold ETFs, let us try to understand the mechanism behind these funds. 

• Step 1: Fund House Buys Physical Gold 

The Asset Management Company (AMC) collects money from investors like you and uses it to purchase standard gold bullion.

• Step 2: Gold is Stored in Secured Vaults 

The physical gold that is purchased is stored in secure, insured vaults with a custodian. This ensures the safety of the underlying asset.

• Step 3: ETF Units are Issued Against the Gold 

The fund house then issues gold ETF units to investors corresponding to the gold held. The value of these units is directly linked to the prevailing price of gold.

• Step 4: Investors Buy and Sell Units on the Stock Exchange 

The gold ETF units are safely stored in the demat accounts of investors and can be traded freely on the stock exchange anytime during market hours. 

• Step 5: Price Movement Mirrors Gold Prices 

As the market price of physical gold rises or falls, the Net Asset Value (NAV) of the gold ETF unit moves in tandem.

Key Features of Gold ETFs

Gold ETF investments come with distinct features that make them attractive to modern investors. 

• Purity (99.5% or Higher) 

The underlying asset of gold ETFs is physical gold bullion of very high purity (99.5% or higher).

• Transparency 

The prices of ETFs are publicly available on the stock exchange. You can see the real-time value of your investment without any hidden calculations at anytime.

• Liquidity 

Gold ETFs are highly liquid and can be sold instantly on the stock exchanges during market hours. There is no need to visit a jeweller or negotiate the selling price.

• Real-Time Pricing

Unlike mutual funds, where the Net Asset Value (NAV) is only calculated at the end of the day, gold ETF prices fluctuate and are updated constantly throughout the day.

• No Physical Storage Issues 

Since gold ETF units are stored safely in your demat account in electronic form, there is absolutely no risk of theft, mutilation, loss or any other storage concerns. 

Why Do Investors Invest in Gold ETFs?

Here are some of the gold ETF benefits that often compel many investors to invest in the instrument.   

• Hedge Against Inflation 

Gold ETFs can protect your purchasing power as the price of the underlying precious metal typically rises when the value of currency falls due to inflation.

• Portfolio Diversification 

Gold often performs well when stock markets are down. Holding a gold ETF balances your portfolio risks effectively.

• Protection During Market Volatility 

During times of economic uncertainty or geopolitical tension, gold acts as a safe haven and stabilises your overall investment value.

• Easy Access to Gold Investments 

Unlike gold jewellery or bullion, you can start investing in gold ETFs with a small amount of capital.

• Cost-Efficient Compared to Physical Gold 

Physical gold often comes with making charges and high premiums. Gold ETF investments are more cost-efficient, making them more profitable in the long run.

Gold ETF vs. Physical Gold

The table below can help you understand the differences between gold ETF vs. physical gold.

Gold ETF vs. Digital Gold vs. Sovereign Gold Bonds

Here is a quick comparison table to help you distinguish between the various gold investment options available in India.

Advantages of Gold ETFs

The gold ETF benefits extend beyond just convenience. Here is a quick overview of some advantages.

• Since the units are stored electronically in a demat account, there is no risk of theft.
• Gold ETFs do not carry any management charges, which helps increase net returns.
• The units of a gold ETF can be bought and sold instantly within seconds using an app. 
• The price of gold ETFs is transparent, universal and updated in real-time. 
• The Securities and Exchange Board of India (SEBI) regulates these funds strictly, which adds an extra layer of safety.

Disadvantages and Risks of Gold ETFs

As an investor, you must also be aware of the potential downsides of gold ETF investments. Understanding the risks ensures you make an informed decision.

• Gold ETFs expose you to market volatility. The value of your investment can go down if gold prices fall. 
• The ETF returns might slightly differ from the actual returns of gold due to cash holdings or expenses. This is called tracking error. 
• The fund house charges a small annual fee for managing the fund in the form of an expense ratio. This can slightly reduce your overall returns.
• A demat account is mandatory for investing in gold ETFs, which adds another layer of cost in the form of Annual Maintenance Charge (AMC) for the demat account. 

Taxation of Gold ETFs

If you sell your gold ETF units within 12 months of buying, the profit is classified as Short Term Capital Gains (STCG). STCG is added to your total income and is taxed as per your tax slab. Meanwhile, if you hold the units for more than 12 months, the profit is treated as Long Term Capital Gains (LTCG). LTCG is taxed at 12.5% without indexation benefits. 

Who Should Invest in Gold ETFs?

Gold ETF investments are highly versatile. Here is a quick overview of who should consider investing in them. 

• Conservative Investors 

If you prioritise capital safety over high-risk high-returns, gold ETFs could be a suitable option for you as it adds stability to your portfolio.

• Long-Term Investors 

Gold tends to appreciate over the years. Therefore, if you have a long-term horizon of 3-5 years, you can benefit from the value appreciation offered by gold ETFs.

• Portfolio Diversifiers 

If your portfolio is heavy on equities, adding gold ETFs can help balance the risk and reduce the impact of market volatility.

• Investors Avoiding Physical Gold 

If you want exposure to the precious metal but wish to avoid the safety concerns and purity risks, making a gold ETF investment is the best option.

How to Invest in Gold ETFs?

The process of investing in gold ETFs is entirely digital and paperless. The following step-by-step guide can help you understand the process.

• Step 1: Open a Demat and Trading Account 

The first step is to open a demat and trading account with a stockbroker. This allows you to purchase and sell gold ETF units on the exchanges.

• Step 2: Search for Gold ETFs 

Once you have opened both accounts, log in to your trading app and search for listed gold ETFs.

• Step 3: Place a Buy Order During Market Hours 

Select the gold ETF you wish to invest in and enter the number of units you wish to buy. You can manually set the price by selecting the limit order option or choose the market order option to purchase at the current market price.

• Step 4: Track Investment like Shares 

Once the buy order is executed, the purchased units will appear in your holdings. You can monitor their value daily alongside your stock investments.

Common Myths About Gold ETFs

There are several misconceptions that often confuse and hold investors back from investing in gold ETFs. Let us address some of the most common myths. 

• Gold ETFs are Risky 

This is not true. Gold ETFs are highly transparent and regulated financial instruments and carry limited risk, which is often in the form of price fluctuations.

• Gold ETFs are the Same as Physical Gold 

Both gold ETFs and physical gold are entirely different investment options. ETFs are financial instruments that actively track the price of gold, whereas physical gold is a tangible asset you can hold.

• Gold ETFs are Only for Traders 

Short-term traders purchase and sell units of gold ETFs with the aim to profit from the price fluctuations. That said, long-term investors can also benefit by investing in them. By making gold ETF investments, they can diversify their portfolio and accumulate wealth over the long run.

FAQs on Gold ETF

• What is the minimum investment in a gold ETF? 

You can start investing by purchasing as little as just one unit of a gold ETF, which represents approximately 0.01 grams or 1 gram of gold, depending on the fund. 

• Is a gold ETF safe? 

Yes, it is a highly safe investment option as the underlying gold is stored in secure vaults and the funds are regulated by the SEBI.

• Can I redeem a gold ETF into physical gold? 

Yes. Some mutual fund houses let you redeem your gold ETF investment as physical gold as long as you meet the minimum quantity requirement, which is often 1 kilogram.

• Is a gold ETF better than physical gold? 

Yes. For investment purposes, gold ETFs are more cost-effective, transparent and liquid compared to holding physical metal.

• Do gold ETFs pay dividends? 

No. Gold ETFs do not pay dividends. The returns from it come solely from the appreciation in the price of gold.

Conclusion

A gold ETF is a modern, efficient and smart way to gain exposure to the precious metals market. It eliminates purity concerns and storage risks entirely, while offering you the full benefit of price appreciation.

Now that you know how a gold ETF works, consider allocating a portion of your portfolio to this instrument for better diversification. Instead of locking money in idle jewellery, you can let your capital work efficiently through these funds.