ATM :: Why gold purchases should not be part of financial planning?


Abhijit Gulanikar | Tuesday, 17 November 2015 – 8:30am IST | Agency: dna | From the print edition
The track record of gold, before adjusting for transaction costs, for giving returns is fair.

ATM

For Adwait and his family Diwali is festive time to be enjoyed with family and friends. It is also time to buy gold. Along with Diwali, he buys gold every year during Akshaya Tritiya. He buys gold during all important life events like birth of his daughter, wife’s 30th birthday. This gold has in most cases bought as ornaments for his wife, daughter or himself. He recons that large portion (around 30-35%) of his savings is in form of gold. Adwait is not alone and many Indians have similar habits making India the largest purchaser of gold.

This mindset of investing in gold is received wisdom we have learnt from our forefathers and has been a long tradition in India. But this tradition is from era when financial instruments were not well developed. Today investments that are safer than gold will provide returns equal to or higher than the return on gold. By safer I mean both physical security and price security (capital guarantee). Most financial instruments are in electronic form or physical receipts that can be encashed only after due authentication by the owner (signature/password-OTP). Gold is, on the other hand, subject to theft and robbery. One needs to protect it buy hiring safe deposits lockers or other similar arrangements. Gold is generally safe from point of price security but it is also subject to market fluctuations like other commodities. We have had period where the price of gold has not recovered to previous peak for 4-5 years. Like price of gold is currently around Rs 26,000 for 10 gram, lower than Rs 31,000 we had three years ago.

The track record of gold, before adjusting for transaction costs, for giving returns is fair. Analysis of gold prices over last 40 years reveals that average return for long-term holding (10 years or more) is slightly lower than 10%, whereas inflation during the same period averages around 8%. Gold thus does provide positive real returns, i.e returns higher than the rate of inflation.

Above analysis is purely theoretical based exchange traded prices of gold. In real life the return will be significantly lower on account of transactions costs. Adwait has paid making charges every time he has purchased the ornaments. Making charges vary considerably from jeweller to jeweller but are substantially higher than zero transaction charge for making a bank fixed deposits or buying national saving certificate. Adwait has remade old ornaments from time to time and has paid a deduction for old ornament, and at the same time making charges for the new ornament. Adjusting for these costs and cost of safe keeping the return on gold would not be higher than rate of inflation.

Adwait should go ahead with his tradition of purchase of gold during Diwali as it has a huge sentimental value. Display of ornaments during social occassions also has a huge social value. However it would be judicious to reduce the amount of gold that he purchases. For important life events like his daughters 10th birthday, instead of buying a gold chain, he could invest the same amount in a long-term fixed deposit or mutual fund. Gold purchases should be done purely for sentimental/social reasons and not as part of his financial planning.

The writer is chief officer-business strategy, SBI Life Insurance

Source : http://goo.gl/w3wKkv

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