How To Save While Buying Gold As An Investment – Forbes

With an increase in inflation, investors tend to turn to investment options such as gold to hedge themselves. As prices in the U.S. climbed 6.2% year-over-year, the largest increase since November 1990, it could be a good time to evaluate how you can save money when considering investments in gold. 

There are three ways in which you can earn more returns on gold transactions:

1. Investment Transaction: Increasing the Returns by Earning Passive Income

To understand how to save money, we need to first understand where we are spending more. In India, it is a common practice to buy gold coins on various auspicious occasions like Dhanteras, Diwali, etc. It’s a great practice as it keeps increasing the investments, but now let’s see how we end up spending excess & reducing the return.

Let us compare two scenarios, one wherein our investor friend, Mr A buys a gold coin of 1 gram, the other where he chooses sovereign gold bonds (SGBs) as an option for the same quantity.

Gold Coin : With gold coin, the investment cost of INR 5,000/gm also attracts making charges of say at minimum, INR 100 per gram along with 3% GST and the total cost thus becomes INR 5,253. This simply means, Mr A paid 5.06% in addition to the actual cost. 

SGB investment: SGBs in layman terms, are bonds issued by the RBI, but the variation being the underlying here is gold. This product just as normal bonds offer interest. The important point is, the interest becomes a passive source of income, in addition to the increase in the gold’s price. 

Thus Mr A here, would pay INR 5,000 and the brokerage charges, which would be, considering the maximum cost, 1% of the investment value. The interest that he would earn would be 2.5% pa on the face value of the investment. Thus, the actual cost becomes INR 5,050 also attracting the lucrative 2.5% interest which he otherwise wouldn’t earn.

The choice here becomes clear, the cost of investment in the first option would take around more than half a year to recover considering the average compound annual growth rate of 10% in a span of 30 years, whereas our SGB investment starts yielding returns in the very year of buying it. 

2. Investment Transaction: Increasing the Returns by Saving on Costs

Here the understanding of savings needs a deeper understanding of how the demand and supply market works along with a detailed analysis of the face value and investment value returns.

To understand this down, evaluate these points:

• Low volumes, attractive prices: The first SGB was launched in 2015 and even today, the awareness of the product is very low. Hence the volumes for secondary sale, on the exchanges are very low and sellers are ready to sell at a discounted price. This discount can be up to 5% on comparison to the spot price of gold. So, investors can take advantage of the situation and buy gold at a discount, and hence increase their return.

• High face value, at low investment cost earns higher returns: The bonds are issued at a predetermined price. This price is the face value of the bond, and interest is calculated on the face value of the bond. Investment price, on the other hand, is the price for which we can buy it today, it is influenced by the current market prices. 

The investors should thus, consider buying SGBs from a tranche which was issued at a high face value and is now trading at low prices. For example, suppose a SGB was issued at the price of INR 5,300/per unit. The interest amount is fixed at 2.5% of the face value INR 5,300 and the same tranche is trading at INR 4,800/per unit. 

As the interest is fixed but our investment cost was lower, the interest rate calculated on our investment value gives an effective interest rate of 2.76% p.a. We achieve two goals here, reduced cost, higher returns. But note, this is only possible if the SGB is trading below the issue price.

3. Loan Transactions: The Savings Due to Gold Loans

Businessmen usually need working capital to run their business, but to avail a working capital loan one requires a good credit score. It thus becomes out of reach for the small vendors who want to run their business smoothly, which ends up turning them towards gold loans. Moreover, the cost of working capital loans is very high. Also, generally salaried people usually have a decent credit history, but that leaves them with options like personal loans at times of crisis. 

Historically, gold loans have been a preferred loan for Indians in the time of crisis not only for individuals but also to support businesses. This is because while giving a gold loan, the banks don’t take the creditworthiness of the customer into a detailed consideration because the loan is secured against the gold pledged.

Let us understand why a gold loan is preferred and then elaborate on the saving options therein:

Cost effectiveness: 

Working capital loans cost 15% to the pocket, and personal loans can range at interest rates of 15-18%, which is too high an interest burden to bear. The interest rate on gold loans comparatively, falls in the range of 8-9% which is cheaper and with less focus on the credit history, a feasible option. 

Reducing the effective rate of interest with the help of SGBs:

Let’s bring Mr A back into the picture: He is a manufacturer and he, knowing the cost effectiveness, regularly takes gold loans for his working capital requirements. 

He has two options at hand: one pledge jewelry and the other pledge SGBs.

1. Pledge Gold Jewelry: He has specifically allocated a portion of his jewelry for the loan purpose. He pledges gold jewelry of INR 5 lakh and takes a gold loan, first the hair cut of around 10% will be deducted from the value of gold, and then 65% of that will be given as loan. Thus, the loan amount is INR 2,92,500. This is because of concerns like purity and prospective price fluctuations. Additionally, a processing fees of minimum 0.5% will be charged

Now if the loan is for a tenure of 1 year and interest rate is 10%, Mr A will have to return INR 3,21,750 at the end of the year.

2. Pledge SBG :  SGBs which are stored in his de-mat account are pledged here. He will get loan at a flat hair cut of 35%, because there are no concerns about the purity of SGBs. So now the loan amount will be INR 3,25,000. Processing fees would also be charged here. Now because, in this scenario Mr A has SBGs, he is entitled to get the interest on the SGBs, even though he has taken loan against it. Hence, Mr A will get 2.5% interest on INR 5 lakh i.e. INR 12,500 from RBI. Now after a year Mr A will have to return INR 3,25,000+10%, that is INR 3,57,500.

To summarize the example:

So, in the SGB scenario Mr A saved INR 9,087.5. In addition to that, he got the benefit of an excess funds of INR 32,500 which support the working capital, strengthening it for better business opportunities. In the SGB scenario the cost of loan can be reduced further if the effective rate of interest from SGBs is increased, as discussed in the investment transactions, saving the cost analysis. 

Thus, gold in the SGB form proves lucrative as an investment option than traditional forms of gold and can help you save while making an investment in gold.  

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