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Liquid Fund vs Arbitrage Fund

Highlights

  • What is a Liquid Fund and an Arbitrage Fund?
  • What are those factors by which you differentiate between Liquid Funds and Arbitrage Funds?

There are many investors who want to park their hard-earned money for the short term. But there are so many options around us that we are bound to get confused. Fixed Deposits and Savings Bank Accounts have always been a choice for most. But if you want to capitalize more, you can trust on any of these two mutual funds – arbitrage fund and liquid fund, arguably the best short-term investment options. Liquidity, return on investment, risk factor, tax benefits are some factors on which you can differentiate liquid funds and arbitrage funds. The article will differentiate these two to help you choose the right option. But first, let’sknow what they are.

What is Liquid Fund and Arbitrage Fund?

Before coming on to the differences between them, it’s important to know them separately. Considered as a low-risk investment, Arbitrage Fund is an equity-focused mutual fund that encashes the price difference between the cash segment and future segment of the same asset. This difference is the return that you will get. An arbitrage fund is purely treated like an equity mutual fund. 

While, a liquid fund, as it is evident from its name, is extremely liquid in nature. It is a kind of open-investment debt scheme which invests in short term market instrument schemes such as government securities, treasury bills, commercial papers, etc, having a maturity period of up to 91 days. 

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Factors That Help Differentiate Liquid Funds from Arbitrage Funds?

To understand the differences between a liquid fund and an arbitrage fund, we have provided you a few important factors below. Read, understand and anlayze the options carefully. 

Liquidity of your Investment

When you invest in any fund, there will be certain situations when you would want to encash your investment as soon as possible. It is called the liquidity of a certain fund. Liquid funds are considered to be far better than arbitrage funds in terms of liquidity. You will need at least 3 to 5 days in order to redeem an arbitrage fund, while the encashment of liquid funds can be processed within 24 hours. 

Return on Investment

Anyone who invests in these short-term options would want to gain a healthy return on their investment. So between the two, arbitrage funds give slightly better returns compared to the returns given by liquid funds. In the times of volatile market, arbitrage funds prosper due to the ample opportunities of encashing the arbitrage in the market.

Risk Factor

Talking about the risk involved with these two funds, liquid funds are considered to be a much safer investment option as compared to the arbitrage fund, primarily because of the fact that it invests mainly in debt-related instruments. While arbitrage funds, a type of equity fund, suppose to have more risk as it depends on the market volatility and arbitrage opportunities in the market. Arbitrage funds thrive on the bullish market where there are enough opportunities to maximize the difference between the cash and futures market.

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Investment Horizon

Before investing in any of these two funds, it’s important to know the period you are looking to invest in. In the case of liquid funds, an investment horizon of a few days or weeks would be sufficient. But it would not be applicable in the case of arbitrage funds as you would need time to pick the arbitrage opportunities which would be few in a short span of time. An ideal investment period in the arbitrage fund would be 3 months or more. A period shorter than this will fetch erratic returns on your investment.  

Exit Charges

Exit charges are the fees charged by the particular Asset Management Company (AMC) from the investor at the time of exiting or redeeming the fund that she or he has invested in. Liquid funds don’t charge any kind of exit penalties while when you want to exit from the Arbitrage funds. It charges 0.25% to 0.5% if it is within the first three to six months (premature withdrawal) of the investment. 

Tax Benefits

This is one of the key differences between the two funds. In liquid funds, the tax bracket in which you fall will define the tax benefits. The short-term returns generated from the liquid funds will be added to your income and will be taxed accordingly. Consequently, an investor in the highest tax bracket margin will find it inefficient. While a non-earning people will find it efficient.

On the other hand, short-term capital gains (period of less than 1 year) from arbitrage funds will attract a flat 15% tax which is quite lower as compared to the 20% tax in liquid funds. However, you invest in arbitrage funds for a period of more than 1 year, your gains will come into the category of long-term capital gains (LTCG). If this goes above the value of ₹ 1 lakh, it will be taxed at the rate of 10% without any single benefit of indexation. 

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Conclusion

When you invest in arbitrage funds, the fund manager will need to conduct thorough market research to channelize your money efficiently amid price volatility. On the other hand, your liquid fund portfolio must have top-rated money-market instruments, such as certificates of deposits, treasury bills, commerical paper, etc.