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Arbitrage funds : Excellent way to park short-term money

What do you do when you have to temporarily park your money for say a few months to around a year?

More often than not, it simply stagnates in your Savings A/c, earning a teeny-weeny 4% interest and that too taxable. Not a smart thing to do, you would definitely agree.

Or, at best, you go for the all-time favourite Bank Fixed Deposit. Again, not an intelligent choice, you would surely agree. Why?

Because, even if you get around 9% interest, effectively you make only about 7.2% or 6.3% returns after tax, depending on whether you fall under the 20% tax slab or 30%. 

This is where Arbitrage Funds enter the scene.

The "pre-tax" returns from arbitrage funds would generally be similar to the returns from the Bank FDs. (Returns from such funds averaged around 9% in last one year.) 

However, the interest income on bank FDs is taxed differently as compared to the gains from arbitrage funds. 

And this is where you can dramatically improve the amount that you get in hand after taxes... with practically the same level of safety as the FDs.

If your investment remains in the arbitrage funds for less than a year, your tax liability would be only 15%. So your effective post-tax returns would be about 7.65%.

And, if you stay invested for more than a year, your tax liability drops to Zero. So your effective post-tax returns would be 9%.

As is quite evident, returns from arbitrage funds handsomely beat the 6.3% or 7.2% post-tax returns from bank FDs.

By the way, arbitrage funds also rescue you from the tedious TDS.

Just a few significant points to remember when you go to buy arbitrage funds...
... Though there may be no restriction as to when you can withdraw your money, ideally such funds should be redeemed on the last Thursday of the month
... Since good arbitrage opportunities are limited, choose funds with smaller corpus
... To enjoy the favorable tax treatment, opt for funds that have equity / derivatives exposure exceeding 65%
... Be aware of the exit load and time your exit accordingly

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