An angry reader writes, “I searched all your articles on gold and found that you have repeatedly recommended against using Sovereign Gold Bonds in an investment portfolio. Why is this so? They are tax-free when held to maturity, and you get extra interest. No other gold instrument has these features, yet you are against this. Why?”
First of all, we are not against the use of Sovereign Gold Bonds. We recommend using it only if purchasing gold jewellery is your future need in 8-10 years (for longer durations, equity + debt will suffice). Then (and only then), Sovereign Gold Bonds are a tax-free and, more importantly, risk-free way to accumulate funds for future gold purchases. See Sovereign Gold Bond Scheme: When to buy and when not to!
Second, we have shown again and again that gold is not an inflation hedge (at least not an efficient one) and adding a small amount of gold (10% – 20%) will not make a big difference to an investment portfolio. Gold is an unnecessary passenger in a portfolio. See: Can I add 10-20% gold to my 15-year investment portfolio? Also, Can I use Sovereign Gold Bonds in my retirement portfolio?
So we recommend not using any gold instrument for an investment portfolio. That is when your only motive is to gain from gold price movement and not buy any jewellery or any other form of physical gold. This is because gold does not offer a reward commensurate with its risk and is as risky as stocks, if not riskier! See Gold vs Equity (Sensex) 40-year return and risk comparison.
When we add an instrument into an investment portfolio in the name of “diversification”, we should be able to buy and sell it freely once or twice a year to rebalance the portfolio. That is, reset and realign the current asset allocation with the desired one.
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Diversification without rebalancing is just clutter. Sadly, even for those who insist on adding gold to a portfolio, Sovereign Gold Bonds have liquidity issues when sold or purchased mid-term. That is, the buy or sell price can be quite different from its current value leading to unnecessary losses (or intentional gains). And this is an unknown determined by demand vs supply.
The problem is most investors buy Sovereign Gold Bonds in the name of “diversification” only because it is tax-free. Gold returns are extremely uncertain and often negative, as shown before: What returns can we expect from Sovereign Gold Bonds? Tax-free is of no use if the return is negative!
The only way to reduce this risk in an investment portfolio (this risk is not relevant if you ultimately want to buy gold) is to rebalance systematically without worrying about taxes. A gold fund is better suited for most retail investors in this regard (An efficient gold ETF will also work, but one has to be careful with price-NAV deviations).