I have a contingency fund of Rs 2 lakhs in a savings account. For better tax adjusted returns liquidity and safety I am planning to invest this money in debt funds. I am confused which one to pick from the debt categories of short term, ultra short term, income, gilt short-term, gilt long-term or liquid funds. All of them look nearly the same. I thought of FD's but I might end up with a premature withdrawal and I already have an FD for Rs 1 Lakh.
- Vishnu Vardhan Chowdary
There can be different levels of contingencies-- those that require cash from wallet, those for which you can wait a while and withdraw from savings account, or those that can be held for a day or two until you can redeem your investment. You should keep a good part of the money as cash at home or in a savings account for their easy withdrawal facility and put the remaining in liquid funds.
Liquid funds can be used as an alternative to short-term fix deposits. Most schemes have a lock-in period of a maximum of three days to protect against procedural (primarily banking) glitches, and offer redemption proceeds within 24 hours. The minimum investment size in a liquid fund varies from Rs 25,000 to Rs 1 lakh. Their maturity makes them relatively less sensitive to interest rate fluctuations, compared to other debt funds.
Short-term capital gains tax applies on liquid funds that are held for less than a year at the income tax slab that one falls in. However, there is tax efficient strategy that you can adopt. Dividends from liquid funds are tax-free in the hands of investor, which makes them more attractive than bank fixed deposits. Consider opting for dividend reinvestment when investing in a liquid fund because dividends stripped will be reinvested as units and will be considered as fresh investments. This way the capital gain will be very low. In case you do plan to hold the investment in liquid fund for over a year; opt for the growth option to benefit from the indexation benefits.
This article was originally published on May 30, 2013.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
