Investing in Gold ETF vs Gold Mutual Funds: Which form of gold gives you higher returns?

With the recent drop in gold prices, lot of folks are likely to jump into gold investments since it carries a high sentimental value for Indians and is seen as a traditional safe haven during uncertain times. To avoid the hassle of buying and storing physical gold, many investors are looking at alternatives like gold ETFs and gold mutual funds. But figuring out which option is better can be a bit tricky.
Here, we will break down the key difference between gold ETF and gold mutual funds, look at their cost structures tax implications and see which one actually yields better returns. This way you can take an informed decision based on your financial goals and risk appetite.

Difference between gold ETF vs gold mutual funds

Gold ETF or Exchange Traded Funds primarily track the price of physical gold. These are passively managed funds meaning that the fund manager makes only minor, periodic tweaks to keep the fund aligned with the performance of the underlying assets. Each unit of these funds represents 1 gram of 99.5% pure gold, so that the ETF price is directly linked to gold price.

To invest in a Gold ETF, you need a demat account since ETF units can be traded on stock exchanges. The traded price of an ETF fluctuates throughout the day like stocks, as it is bought and sold on the exchange. For instance, if the gold price increases by 5%, the ETF value also typically increases by 5% and the same happens when the price falls.

Gold ETFs gives investors an exposure to gold in a digital format, eliminating threats of theft or purity issues. It also provides easy liquidity and ease of transaction.

On the other hand, Gold Mutual Funds are generally more beginner-friendly for investing in gold compared to Gold ETFs, as you don’t require a demat account. These funds invest in gold or gold related assets including bullion, coins, stocks of gold mining companies, and gold ETFs. The key difference? You can start investing in Gold Mutual Funds through SIPs, just like any other mutual fund.

Prithviraj Kothari, Managing Director at RiddiSiddhi Bullions Ltd. said, “Gold mutual funds are more convenient for new investors, while ETFs offer more liquidity and real-time trading flexibility”.

Also read: Gold prices fall: Should you buy more or wait? Experts share key investment strategies

Let’s take a look at the comparison table for better clarity:

Hidden charges in gold ETF and gold mutual funds

Although gold ETFs may seem to have lower costs than gold mutual funds, they can come with some hidden fees. The main cost associated with gold ETFs is the expense ratio, which covers fund management, administrative expenses and other operational costs. Additionally, investors may incur brokerage fees or charges for maintaining a demat account.

Rajeev Singh, Regional Head, Leading Private Bank, says “Gold ETFs typically have a lower expense ratio (around 0.4%–0.7%) but involve brokerage, demat charges, and bid-ask spreads”.

Investors in gold ETFs might also encounter another hidden cost called the tracking error. This is the difference between the actual returns of the fund and the returns of the benchmark index over a certain timeframe. A smaller tracking error means that the ETF closely follows the price movements of gold or the benchmark.

“The tracking error which is the difference between underlying gold prices and ETF or FoF is one of the hidden charges that investors may face” says Tapan Patel, Fund Manager-Commodities, Tata Asset Management.

On the other hand, gold mutual funds generally have a higher expense ratio compared to Gold ETFs and may include additional charges like exit and entry loads.

Kothari said, “Gold mutual funds have slightly higher costs (0.8–1.5%), including fund management and administrative fees”.

“Gold Mutual Funds charge their own total expense ratio (TER) in addition to the ETFs, and may include exit loads and distributor commissions, making them slightly more expensive overall,” says Singh.

Also read: Silver taxation explained: How your earnings from physical silver, silver ETFs and mutual funds are taxed

Returns of gold mutual fund and gold ETF in the last 10 years

The returns of gold ETF and gold mutual funds over the past 10 years show that both forms of gold have delivered more or less similar average annual returns.

“Over the past 10 years, both Gold ETFs and Gold Mutual Funds have delivered average annualized returns of around 13–14%, largely tracking international gold prices,” says Kothari

“Returns fluctuated depending on global trends, rupee depreciation, and macroeconomic events such as inflation and geopolitical risks influencing gold demand” he added.

Which one, gold ETFs or gold mutual funds, gives higher returns after net charges?

Let’s check out which option offers you better returns. Gold ETFs tend to provide a bit higher returns compared to gold mutual funds because of their lower expense ratios and overall charges.

When asked about why there is a difference in return from Gold ETFs and Gold mutual funds, Patel from Tata Asset Management said that the return differentiation is largely attributed to expense ratio.

Patel adds: “Gold ETFs have generally given higher returns because of lower expense ratio excluding brokerage. Gold Fund of funds on other side includes expense ratio of underlying ETF also. Gold ETFs has direct exposure to gold prices while in gold fund of funds timing of deployment may affect the point-to-point basis returns.”

Taxation of gold ETF and gold mutual funds

Both the forms of gold investments are subject to both short term capital gains (STCG) tax and long term capital gains (LTCG) tax. The taxation rules for both forms are similar.

Here’s the snapshot of tax rates as per Milin Bakhai, Partner, Direct Tax, N. A. Shah Associates LLP: