Gold ETFs vs Gold Funds: What is better for your Portfolio

Gold has historically served as the foundation for valuing currency, reflecting its importance as a universal store of value. Its appeal lies in its ability to offer stability during economic uncertainty by acting as a hedge against inflation and currency fluctuations. 

However, modern investors now have more flexible and convenient alternatives to physical gold, such as Gold ETFs (Exchange-Traded Funds) and Gold Mutual Funds.

Gold ETFs represent direct investments in gold and are traded on stock exchanges like shares. On the other hand, Gold Mutual Funds indirectly invest in gold through Gold ETFs, offering professionally managed exposure to this precious metal.

This blog delves into the nuances of Gold ETFs and Gold Mutual Funds, helping you align your choice with your financial strategy and objectives.

What Are Gold ETFs?

Gold Exchange Traded Funds (ETFs) are investment instruments that track the price of physical gold. Traded on stock exchanges like shares, they eliminate the need for physical storage. Each unit typically corresponds to one gram of gold or its monetary equivalent.

Investors can trade Gold ETFs during market hours at prevailing prices, requiring a Demat and trading account. These funds are cost-efficient, with lower expense ratios than traditional gold investments like buying physical gold or investing in gold mutual funds. They ensure high purity as the underlying gold is securely stored in authorized vaults.

Gold ETFs offer liquidity and provide exposure to gold price movements without the hassles of handling physical gold. Their transparency and convenience make them an attractive choice for investments.

What Are Gold Mutual Funds?

Gold Mutual Funds are open-ended funds that allocate funds to gold-related assets, such as Gold ETFs or gold mining companies, rather than physical gold. These funds offer exposure to gold’s price movements without needing a demat or trading account.

Unlike Gold ETFs, Gold Mutual Funds are purchased directly from fund houses or intermediaries. They are actively managed by professional fund managers who allocate investments to maximize returns and diversify within the gold sector to mitigate risks.

A significant benefit of Gold Mutual Funds is the flexibility of Systematic Investment Plans (SIPs), allowing regular, small investments. This makes them accessible for individuals seeking exposure to gold without requiring large upfront capital.

Key Differences Between Gold ETFs and Gold Mutual Funds

Investors often compare Gold ETFs and Gold Mutual Funds to determine the best option for their portfolio. Below is a detailed comparison based on critical factors:

Aspect	Gold ETFs	Gold Mutual Funds
Expense Ratio	Gold ETFs typically have a lower expense ratio, ranging between 0.3% to 0.8%	Generally higher, ranging between 0.5% to 1%
Liquidity	Highly liquid during market hours but dependent on trading volumes. Low volumes can restrict liquidity	Less liquid; transactions depend on the mutual fund house’s redemption process and settlement periods
Trading and Pricing	Prices are real-time and fluctuate during market hours based on demand and supply on exchanges	Prices are calculated at the end of the day using NAV (Net Asset Value), not real-time like ETFs
Storage and Management	Gold ETFs represent physical gold held by custodians, eliminating the need for investors to store gold	The fund house manages storage indirectly through Gold ETFs, and investors don’t hold physical gold
Demat Account	A Demat and trading account is mandatory for buying and selling Gold ETFs	No demat account is required, making it more accessible for new or retail investors
Investment Method	Suitable for lump sum investments due to the ease of trading in larger quantities	Allows SIPs, enabling smaller, regular contributions over time
Historical Returns	Comparable to physical gold performance; ~21.94% average 1-year return (as of 2024)	Similar to Gold ETFs; ~21.30% average 1-year return (as of 2024)

Limitations of Gold ETFs

Gold ETFs offer several advantages, but they are not without limitations. Below are key challenges associated with Gold ETFs:

1. Requirement for a Demat Account: A demat and trading account is required to buy or sell Gold ETFs. This adds an extra step and incurs associated costs.
2. Brokerage and Transaction Charges: Every transaction involves brokerage fees and other charges like Securities Transaction Tax (STT). These costs can increase over frequent trades, reducing overall returns, especially for small investors.
3. Market Dependency: Gold ETFs trade on stock exchanges, and their prices depend on real-time market demand and supply. Low liquidity can sometimes cause price mismatches compared to actual gold rates.
4. No SIP Option: Unlike Gold Mutual Funds, Gold ETFs don’t offer Systematic Investment Plans (SIPs), making them less suitable for disciplined, small-scale investments.

Limitations of Gold Mutual Funds

While Gold Mutual Funds offer convenience and accessibility, they come with certain drawbacks that investors should consider:

1. Higher Expense Ratios: Gold Mutual Funds generally have higher expense ratios, ranging from 0.6% to 1.2%. These fees cover fund management and administrative costs, which can erode returns over time, especially for long-term investments.
2. Indirect Gold Exposure: Unlike gold ETFs, which directly represent physical gold, gold mutual funds invest in gold ETFs. This two-layered structure may dilute returns slightly due to additional costs incurred at both levels.
3. Lower Liquidity: Redemption in Gold Mutual Funds depends on the fund house’s processing timelines. The investors cannot sell at real-time prices, making them less liquid.
4. Dependence on NAV for Pricing: The Net Asset Value (NAV) of Gold Mutual Funds is calculated at the end of the day. Investors cannot benefit from intraday price movements.

When should you choose gold ETFs vs. Gold Mutual Funds?

Choosing between Gold ETFs and Gold Mutual Funds depends on an investor’s goals, risk tolerance, and preferences.

1. Gold ETFs
   • Best for Active Investors: Gold ETFs are ideal for those who actively monitor market trends and prefer intraday trading flexibility.
   • Cost-Conscious Investors: With lower expense ratios, Gold ETFs suit investors aiming to minimize costs.
   • Real-Time Liquidity: ETFs provide immediate liquidity, making them suitable for those who may need to sell quickly.
2. Gold Mutual Funds
   • Ease for Beginners: These funds are managed by professionals, making them suitable for individuals with limited market knowledge.
   • No Demat Account Needed: Gold Mutual Funds can be purchased directly from fund houses, appealing to investors without a Demat account.
   • Systematic Investments: SIP options in Gold Mutual Funds help investors build gold exposure gradually, which is ideal for disciplined savers.

Updated Tax Implications After Budget 2024

The Union Budget 2024 brought forward notable changes to the taxation rules for gold investments, including Gold Mutual Funds and Gold Exchange Traded Funds (ETFs). These updates impact how short-term and long-term capital gains are treated.

1. Gold Mutual Funds

Short-Term Capital Gains (STCG):

• Previous Rule: Gains from units held for less than 36 months were taxed as per the investor’s income tax slab rate.
• New Rule: For units purchased between April 1, 2023, and March 31, 2025, gains, irrespective of the holding period, are added to taxable income and taxed at slab rates. For units acquired after March 31, 2025, the holding period for STCG qualification is reduced to 12 months. Gains from units sold within this period are taxed at the investor’s applicable slab rate.

Long-Term Capital Gains (LTCG):

• Previous Rule: Gains from units held for over 36 months were taxed at 20% with indexation benefits.
• New Rule: For units purchased between April 1, 2023, and March 31, 2025, gains are taxed at slab rates regardless of the holding period. For units acquired after March 31, 2025, LTCG tax applies to holdings over 12 months at a flat rate of 12.5% without indexation benefits.

2. Gold ETFs

Short-Term Capital Gains (STCG):

• Previous Rule: Gains from units held for less than 36 months were taxed as per the investor’s slab rate.
• New Rule: The holding period for STCG qualification is reduced to 12 months for units purchased after March 31, 2025. Gains during this period are taxed at slab rates.

Long-Term Capital Gains (LTCG):

• Previous Rule: Gains from units held for over 36 months were taxed at 20% with indexation benefits.
• New Rule: For units purchased after March 31, 2025, LTCG applies after 12 months and is taxed at a flat 12.5% without indexation.

Conclusion

Choosing between Gold ETFs and Gold Mutual Funds depends on your financial objectives, risk appetite, and investment strategy. Gold ETFs suit investors seeking transparency, liquidity, and cost-efficiency with direct exposure to gold. Conversely, Gold Mutual Funds are ideal for those preferring managed solutions or systematic investment options.

Key differences, such as expense ratios and liquidity, should guide your decision. Investors aiming for flexibility and long-term wealth creation must align their choices with their portfolio requirements. Evaluating these options carefully ensures your gold investments support your financial objectives effectively.

Disclaimer:  This content is intended for informational purposes only. PowerUp isn’t responsible for any errors, omissions, or consequences arising from the use of this information.

FAQs

1. What are the primary differences between Gold ETFs and Gold Mutual Funds?
   Gold ETFs are traded on stock exchanges and provide direct exposure to gold prices. Gold Mutual Funds invest indirectly in gold, typically through Gold ETFs, and are managed by fund managers.
2. Which is more cost-efficient: Gold ETFs or Gold Mutual Funds?
   Gold ETFs typically have lower expense ratios than Gold Mutual Funds, which makes them a cost-effective option for investors seeking direct exposure to gold.
3. Who should invest in Gold ETFs?
   Gold ETFs are ideal for investors looking for high liquidity, transparent pricing, and minimal expense ratios. They suit those with demat accounts.
4. Are Gold Mutual Funds better for systematic investments?
   Yes, Gold Mutual Funds are suitable for investors who prefer SIPs or do not have demat accounts. They offer managed exposure to gold.