FinBytes by Finwisor- Arbitrage Funds

After our last FinByte on Emergency Fund, we got multiple requests to explain Arbitrage Funds. We are thankful to those who have given the suggestion and are happy to throw some light on the subject.

What are Arbitrage Funds?

Arbitrage Funds are a category of Mutual Funds. They have given steady returns of ~6% p.a. The risk in these funds is minimal as is in short term debt funds. The biggest benefit is however that they are taxed as equity funds.

What is the difference between equity and debt taxation?

Equities are taxed at 15% in the case where the withdrawal happens before 1 year of investing. In case the withdrawal is post 1 year, the tax is 0% till gains of ?1Lakh p.a. Gains above ?1 Lakhs are taxed at 10%

Debt mutual funds like liquid funds are taxed at the individual’s maximum slab rate if the investment is withdrawn within 3 years. For those with net taxable income above ?10 L p.a., this slab rate comes to 31.2%. If the amount is withdrawn post 3 years, the gains are taxed at 20% with the benefit of indexation

What is indexation benefit?

Indexation is done to factor-in inflation. It is done using Cost Inflation Index published by the IT Department every year. So, if my investment of ?1 L grew to ?1.3 L in 4 years, and indexed cost is ?1.2L, I will be taxed only on ?10K (?1.3L- ?1.2L).

The downside

While enjoying beneficial taxation, arbitrage funds suffer from the drawback of a slightly longer withdrawal cycle. While debt funds are redeemed in T+1 working days, equity funds are redeemed in T+3 working days.

Conclusion

For those in higher tax brackets, arbitrage funds is a better option as an emergency corpus as well as for parking money for short term (<2 years) compared to FDs and liquid funds.

Hope this helps. Wishing you all Financial Freedom.