What Are Gold Funds And Who Should Invest In Them?

Gold has been used as a store of value since time immemorial, but its physical form poses certain constraints. This is where gold funds come into play. Investors can gain exposure to gold without dealing with the hassles of storing and purity levels by investing in such funds. The funds either track the price of gold or its derivatives, making it easy for investors to have access to gold investments.

Key Takeaways

●        Gold funds offer exposure to gold without physical ownership, providing liquidity, diversification, and convenience for modern investors.

●        Returns depend on gold price movements, global factors, and fund expenses, making performance sensitive to external economic conditions.

●        Compared to ETFs and physical gold, gold funds remove storage issues but may involve higher costs.

●        Suitable for diversification, inflation protection, and tactical allocation, but taxation at slab rates can reduce overall returns.

What is a Gold Fund?

Gold funds are mutual funds which have investment options for securities that are related to gold. These investments may be direct or indirect through various means such as owning gold, buying gold-related exchange-traded funds (ETFs), or purchasing stocks issued by organisations associated with the mining or processing of gold. Investors do not have to buy gold to make investments; rather, they purchase units of the fund. The units will increase or decrease in value based on changes in gold prices.

How Do Gold Funds Work?

Gold has been a popular investment for centuries due to its inherent value and perceived stability, especially during times of economic uncertainty. Gold funds provide an alternative to traditional investments like stocks and bonds, and can be used to diversify an investment portfolio. The following process describes how the gold funds work:

1. The fund manager gathers funds from various sources and combines them into one investment fund.
2. The fund manager uses the collected funds to purchase actual gold or to make investments in financial instruments that are closely tied to gold, such as gold futures or gold mining stocks.
3. Based on the price of gold, the gold fund's value varies. The value of the fund increases with an increase in the price of gold and decreases with a decrease in the price of gold.
4. Investors can purchase and sell shares of the gold funds on an exchange, much like they would with stock. The current value of the underlying gold investments determines the share price.
5. For administering the fund and purchasing and selling gold investments, investors often pay fees to the fund manager.

Taxability of Gold Funds in India

Mutual funds that invest in gold are considered "specified mutual funds" when it comes to tax treatment and are exempt from Securities Transaction Tax (STT).

Following Budget 2024 amendments (effective FY 2025–26), gold funds are no longer classified as 'Specified Mutual Funds' under Section 50AA. Gains from gold mutual fund units are now taxed as LTCG at 12.5% (without indexation) if held for more than 24 months, or as STCG at the investor's applicable slab rate if held for less than 24 months.

The previous benefits of Long-Term Capital Gains (LTCG) taxation have been abolished for new investments. Indexation, which allowed you to adjust your purchase price for inflation, is no longer available. However, if you hold units purchased before April 1, 2023, they may still qualify for a 12.5% LTCG tax (without indexation) if held for more than 24 months.

How are Gold Funds Different From Gold ETFs?

Feature	Gold Funds	Gold ETFs
Asset exposure	Gold, ETFs, related securities	Primarily physical gold
Expense ratio	Higher due to management	Lower due to passive structure
Investment method	Bought via the mutual fund route	Traded on the stock exchange
Liquidity	End-of-day NAV transactions	Real-time trading of shares
Minimum investment	Can start small (SIP)	Depends on market lot size
Demat requirement	Not required	Required

Both gold funds and ETFs aim to track gold prices, but their structure and access differ. Overall, Gold ETFs are a more cost-effective and liquid way to invest in gold in India, while Gold funds provide the benefit of active management and diversification. Investors can choose the investment option that aligns with their investment objectives and risk profile.

Also Read More About: Gold ETF vs Gold Fund

Gold Mutual Funds vs Physical Gold

Feature	Gold Mutual Funds	Physical Gold
Storage	No storage needed	Requires safe storage
Purity concerns	No issue	Purity must be checked
Liquidity	Easy to redeem	Depends on buyer availability
Costs	Expense ratio applies	Making charges, storage cost
Investment size	Small amounts possible	Usually, a higher initial cost
Safety	No risk of theft	Risk of loss or theft

Gold mutual funds remove many practical issues linked to physical gold. They suit investors who prefer convenience and ease of tracking.

Read More About:Gold ETF vs SGB vs Physical Gold

Who Should Invest in Gold Funds?

Investing in gold funds can be suitable for various types of investors in India. Here are the categories of investors who may consider them:

1. Diversification Seekers: Investors who want to diversify their investment portfolio beyond traditional equity and debt instruments. Gold often has a low or negative correlation with the stock market, meaning it can act as a cushion to reduce overall portfolio volatility during market crashes.
2. Inflation Hedgers: Investors concerned about the impact of rising prices on their savings. Gold has historically maintained its purchasing power over the long term, making it a reliable hedge against inflation compared to cash.
3. Investors Seeking Convenience and Purity: Unlike physical gold, gold funds offer 24-karat purity without the need for lockers or concerns about theft. They are ideal for those who want to invest small amounts regularly through SIPs.
4. Tactical Investors: Investors looking to take advantage of global economic conditions or geopolitical tensions that typically drive gold prices higher. Because gold funds are highly liquid and allow easy entry and exit without a demat account, they are more efficient than physical jewellery.
5. Long-term Investors (with a Caveat): While gold is a great long-term asset, investors should note that gains are now taxed at their individual income tax slab rates. For those with a horizon of 8 years or more, Sovereign Gold Bonds (SGBs) might be more tax-efficient, though gold funds remain superior for those who need the flexibility to withdraw their money at any time.

Advantages of Investing in Gold Funds

If you are looking to consider Gold Funds as an option, here are some advantages of investing in them:

1. Portfolio Diversification: An investor's portfolio can be diversified with the help of gold funds. Since gold frequently has a low correlation with other assets like equities and bonds, it acts as a stabiliser during market downturns when other assets are losing value.
2. Professional Management: Gold funds in India are managed by expert fund managers who monitor global gold prices, currency fluctuations, and macroeconomic data to make informed decisions. They manage the fund’s objectives and risk tolerance, removing the burden of daily market tracking from the individual investor.
3. Safe Haven Asset: Since gold is regarded as a safe haven asset, it offers protection during geopolitical tensions, high inflation, or periods of global economic instability, helping to preserve capital when markets are volatile.
4. High Liquidity: Gold funds are highly liquid as units can be redeemed online at the prevailing Net Asset Value (NAV). This makes it easier for investors to access their money compared to selling physical jewellery, which often requires purity checks and may involve resale deductions.
5. Ease of Investment (SIPs): Gold funds are accessible to a wide range of investors. Unlike physical gold, which requires a large upfront payment, investors can start with as little as ₹100 or ₹500 per month through Systematic Investment Plans (SIPs).
6. Safety and Purity: Investing in gold funds eliminates the risks of theft and the need for expensive bank lockers. Additionally, every unit is indirectly backed by 99.5% pure 24-karat gold, ensuring there are no concerns regarding the quality or authenticity of the metal.
7. No Making Charges or GST: Unlike physical jewellery, which carries making charges (3%–25%) and 3% GST on purchase, gold funds have zero making charges and are exempt from GST, ensuring more of your money goes directly into the investment.

Risks Associated With the Gold Fund

Investors should be aware that gold funds include risks, just like all investments. The following are some possible risks associated with gold funds:

1. Market Risk: Several variables, including global economic conditions, geopolitical developments, and shifts in supply and demand, can cause fluctuations in gold prices. Additionally, since gold is priced in US Dollars, fluctuations in the USD-INR exchange rate can impact returns for Indian investors.
2. Inflation Risk: While gold is a hedge against inflation over the long term, it may underperform other asset classes like equities during periods of moderate inflation or high-interest rates, leading to lower real returns for investors.
3. Tracking Error Risk: This is the risk that the fund’s performance may not exactly mirror the domestic price of gold. This happens due to the fund’s internal expenses (expense ratio), the cash balance held for redemptions, and the time lag in buying or selling underlying assets.
4. Management and Cost Risk: The decisions made by fund managers regarding liquidity and asset allocation affect performance. The annual expense ratio and potential exit loads (fees for early withdrawal) can reduce the overall net returns of the fund over time.
5. Taxation Risk: Recent changes in Indian tax laws have removed the Long-Term Capital Gains (LTCG) and indexation benefits for gold funds. All gains are now taxed at your individual income tax slab rate, which can significantly reduce the take-home profit for investors in higher tax brackets.
6. Counterparty Risk: Most Indian gold funds invest in Gold ETFs, which are backed by physical gold. While SEBI regulations require these funds to be backed by 99.5% pure physical gold held in secure vaults, a default by the custodian or the third party responsible for the gold's safety represents a theoretical counterparty risk.

Conclusion

Gold funds are a good investment choice for diversification in an individual’s portfolio, particularly for those who wish to gain exposure to gold without having to physically manage it. While Gold Funds provide convenience and flexible options when it comes to the amount of money to invest, the return on investments will depend on the gold price trends in the market. A more pragmatic approach would be to consider gold as a complementary investment to other financial instruments.

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