Liquid Funds Vs Arbitrage Funds
There are different mutual funds, and they serve
different purposes. Some mutual funds help to achieve long-term goals while
other funds cater to our immediate cash requirements.
Liquid funds and arbitrage funds are the two common
types of mutual funds that investors invest to park excess funds with
relatively lower risk to overcome cash needs.
What are Liquid Funds?
Liquid Fund is a type of debt mutual fund that invest
in highly secured debt securities such as treasury bonds, commercial papers.
The risk of liquid mutual funds is comparatively lower than other funds.
According to the market regulator SEBI, the underlying securities of a liquid
fund needs to mature within 91 days.
What are Arbitrage Funds?
Arbitrage Funds are equity funds that aim to take
advantage of the price difference between the cash market and the futures
market. E.g., you buy a product in one location and sell it in another.
Arbitrage funds invest predominantly in arbitrage opportunities that are
available in the cash and futuresequities market that makes these funds
relatively less risky than other equity funds.
However, which type of fund should you choose to
park your money for short-term? Let us take check the differences between
liquid funds and arbitrage funds.
Liquidity:
Liquidity or ease of liquidation of assets is one
of the important factors to consider when you are parking money for the short
term or for immediate requirements. Liquid funds can be easily redeemed, and
the redeemed amount is credited to your bank account. Most of fund houses have
introduced instant redemption facility on liquid funds. With the help of this
facility, you can instantly redeem up to Rs.50,000 or 90% of your investment
value from liquid funds. Fund houses will credit the rest of the amount to your
savings account within one or two working days.
As arbitrage funds are equity funds, you will
receive the redeemed amount in your bank account in three to five working days.
So, if you are looking for an investment choice
that offers instant redemption, you can go for liquid funds.
Tax on Capital Gains:
As liquid funds are debt funds, Long-Term Capital
Gains (LTCG) will apply on investments that remained invested over 36 months
while Short-Term Capital Gains (STCG) will apply on the units that were
redeemed before 36 months. LTCG for liquid funds stands at 20% after
considering the indexation benefits. In case of gains from units that stayed
invested less than 36 months, gains are added to your income and taxed as per
your income tax slab.
As arbitrage funds are equity funds, LTCG is will
apply if you remain invested for over 12 months. There are no long-term capital
gains if the gains are less than Re.1 lakh. Please note that it includes all
equity investments including stocks and other equity mutual funds. For units
redeemed before 12 months, 15% tax on capital gains apply.
Arbitrage funds are tax-efficient than liquid
funds. You can choose arbitrage fund if you desire tax efficiency.
Risk factor:
The underlying securities of arbitrage funds and
liquid funds are different. Arbitrage funds take advantage of the spread
between the cash and futures market. So, these funds give high returns when the
spread is higher, and the return falls when the spread narrows.
Liquid funds invest in the highest quality debt
papers that mature within 91 days. Hence, liquid funds carry less risk than
arbitrage funds. You can go for liquid funds if you don’t have technical
knowledge of the equity markets.
If you are looking to park funds for short-term
needs, liquid funds and arbitrage funds are two popular options. Consider their
liquidity factor, tax on capital gains and risk factor before investing in a
liquid fund or arbitrage fund.
This blog is purely for educational purpose and not
to be treated as a personal advice. Mutual fund investments are subject to
market risks, Read all scheme related documents carefully.
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