Even as Sensex and Nifty raked in splendid gains over the past year, gold has been on a losing spree. The price of the yellow metal in the domestic market has fallen by almost 10 per cent in the last one year while the Sensex gained a whopping 30 per cent. Has the sharp slide in prices lured you into investing a portion of your surplus in gold?

If you are looking to add gold to your investment portfolio, buying physical gold may not be the right thing to do due to three reasons.

For one, gold bought as coins or ornaments is not liquid as converting your gold holding into cash may not be an easy task. Most jewellers may not be willing to pay cash for the gold you intend to sell. They’d rather insist that you buy new gold either in the form of jewellery or as coins in exchange for the old gold. Second, there are several costs attached to jewellery purchases such as wastage and making charges. These charges can cost you as much as 30 per cent of the gold by weight. Three, keeping physical gold at home is a risky proposition. Safekeeping it in a bank or a private deposit locker involves stiff costs.

The better option This is why holding gold in the electronic form either as Exchange Traded Funds (ETFs) or gold funds is a better option anyday. Though both these schemes are offered by mutual fund houses and broadly track the prices of underlying gold, there are many differences between them.

First, gold ETFs hold physical gold of equivalent value as the underlying asset. But in contrast, units of gold funds are issued with gold ETFs as the underlying asset. Second, to buy gold ETFs you need to have an account with a broker through whom you can buy or sell them.

Also, you need a valid demat account to electronically keep your gold ETFs. However, to invest in gold funds, you don’t require a demat or a broking account. The process of buying/selling a gold fund is very similar to investing in any mutual fund scheme. All you need to do is go to the fund house or its distributor and fill in the requisite form to invest in a gold fund.

Handling gold funds In the case of a gold fund, the purchase is made at the NAV notified by the fund house, but in the case of an ETF, you can buy it at the price at which it trades in the exchange. Most gold funds are open ended schemes which means that you can invest any amount of money at any point in time. But in an ETF, the amount that you can invest is limited by the liquidity or volume of ETFs traded in the exchange on any particular day.

The convenience of investing in gold funds obviously comes at an additional cost. Gold funds charge a management fee, in the form of an expense ratio, in addition to the costs you already incur on the underlying ETF units it holds. For instance, Reliance Gold ETF carries an expense ratio of about 1.1 per cent. When you buy it on the exchange, in addition to this, you incur brokerage on purchase or sale of units, which is a one-time fee and may cost less than 0.5 per cent of the transaction value.

But, if you want to buy Reliance Gold Fund you will be incurring an additional 0.7 per cent annually on the expense ratio of this fund. This is in addition to the management fee on the underlying ETF which is already priced in..

This can lower the returns on gold funds. However, gold funds may hold a small portion of corpus as cash, largely to meet redemption request from investors. This can cushion them against underperformance when the gold prices are on a decline.

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