Do not buy Sovereign gold bonds If you don’t know when to exit!

Here is why one should not buy the sovereign gold bonds which are on sale from Since Nov. 5th 2015, despite  the sovereign guarantee and the 2.75% interest rate. From today (5th Nov. 2015), Sovereign gold bonds  will be available for subscription at an issue price of Rs. 2,684 per gram.  Subscribers can buy bonds which are worth minimum 2 gms to maximum 500 gms.

The sovereign gold bonds are for an investment duration of 8 years with an exit option after 5 years. An interest rate of 2.75% will be offered on the purchase price, over and above the appreciation or depreciation in gold price.

Reasons why one should not buy the sovereign gold bonds

1. The most tax efficient way to accumulate gold for a marriage is to buy it: jewels if planning for a marriage and gold bars or coins if you plan to hold it as a hedge in case of war, hyperinflation, etc.
2. Sovereign gold bonds are ways to invest in gold. Not accumulate it.
3. Gold is an extremely volatile commodity and it is ill-advised to buy these bonds which come with a lock-in which is higher than that for ELSS mutual funds (3 years).
4. Those who wish to benefit from gold price movements or those who to add gold for diversification in their investment portfolios are better off with a gold ETF or gold funds.
5. ETFs would have 1% to 1.5% expense ratios and the returns would be lower by that much. However, they offer unmatched liquidity. One can buy on dips and book profits.  This freedom is vital when dealing with volatile instruments and is well worth the expense ratio.
6. The 2.75% interest rate is on the amount invested and not on the maturity value. This interest on the gold bonds shall be taxable as per the provision of Income Tax Act, 1961 (43 of 1961) as income from other sources. Sovereign Gold Bond 2015-16. That is it would be taxed as per income slab.
7. Such a low post-tax interest rate is not worth it considering the associated lock-in.  Imagine the price movement in gold, if these bonds were issued five years ago.
8. Yes, Sovereign gold bonds will beat ETF returns by about 2.4%  for those in 30% slab and about 2.6% for those in 20% slab. Is that enough reward for being locked in for 5 years with a volatile asset class? A vehement no, in my opinion.
9. Gold is not a fixed income asset class. Investing in gold is riskier than investing in stocks! So I expect a risk premium. This risk premium should be free from constraints. The lock-in period with a small interest rate that would be taxed as per slab are not good enough for me.

Budget 2016 Update (does not change conclusions)

It is proposed to provide that redemption by an individual of Sovereign Gold Bond issued by Reserve Bank of India under Sovereign Gold Bond Scheme, 2015 shall not be charged to capital gains tax. It is also proposed to provide that long terms capital gains arising to any person on transfer

Conclusions:

Buy physical gold (not ETFs) if you wish to accumulate gold for a marriage or as a hedge.

Use ETFs invest in gold to diversify your portfolio.

Do not buy the sovereign gold bonds which are currently on sale.