Gold is a very important asset class for investors. Gold not only has an important cultural significance in India, but since it has been used traditionally as store of value all over the world, over a long period of time, gold is seen as a hedge against inflation. Also, based on historical data, gold prices have a negative correlation with equity prices. So gold can also be used as a hedge against equity risks.
Broadly, there are two forms of investment in gold. Investors can buy gold in physical form as jewellery or also as bars or coins. While jewellery has aesthetic value, it involves making charges and risk of impurities. Buying gold in bars or coins mitigates the risk of impurity (you need to check nevertheless) and also does not involve making charges. However, buying gold in physical form (whether in the form of jewellery or bars /coins) involves the cost of storage, e.g. bank locker charges.
Investors can also buy gold in the paper (or electronic in lieu of paper for convenience) form. Buying paper gold mitigates the issues with buying physical gold. Paper gold tracking the price of gold in the market has the same value as that of pure physical gold; in fact, the value of paper gold in monetary terms is more than gold jewellery (because there are no making charges involved).
Investors can buy paper gold either in the form of gold ETF or gold fund of funds. Gold ETF is an exchange-traded fund (ETF) that aims to closely track the price of gold. Gold ETFs are units representing physical gold which may be in paper or dematerialised (electronic) form. The units of the gold ETFs are traded on the stock exchange like shares of a company. To buy and sell gold ETFs on the stock exchange, you need to have demat and trading accounts. Investors have to pay brokerage and other transaction costs to buy and sell ETFs. In addition, investors have to bear fund management fees of the ETF over the period of investment. These costs notwithstanding, ETFs is a cheaper and safer way of investing in gold.
Many investors who do not directly invest in stock market may not have demat accounts. If investors do not have a demat account, you can invest in gold fund of funds. Gold fund of funds are mutual fund schemes which invest in gold ETFs. The ongoing expense of gold fund of funds is slightly higher than ETF, but it is a convenient and safe way of investing in gold for retail investors.
Gold ETFs and gold fund of funds are taxed like debt funds. Short term capital gains (investments held for a period of less than 36 months) are taxed as per the income tax rate of the investor. Long term capital gains (investments held for more than 36 months) are taxed at 20% after allowing for indexation benefits.