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Liquid funds or arbitrage funds?

Though arbitrage funds do not invest directly in stocks, they are classified as equity schemes for the purpose of taxation

Please tell me whether a liquid fund or an arbitrage fund is better suited for a retired person, who wants to invest with an investment horizon of one year. Can the money be withdrawn before one year? What will be the penalty on such withdrawals? What are the chances of losing money in an arbitrage fund? Is it safe?
- PK Saran

Liquid funds are ideal to park money for a few days to a few weeks. You should consider investing in ultra short-term schemes if you are investing for a few months and up to a year. Arbitrage funds look for the price difference between the cash and the derivative market to generate returns. As you can see the returns from these funds would depend on the arbitrage opportunities available in the market. Both these funds are relatively safer and they may offer a marginally higher post-tax returns than bank deposits.

Though arbitrage funds do not invest directly in stocks, they are classified as equity schemes for the purpose of taxation. This give them an edge over liquid funds. If arbitrage funds are sold before a year, the short-term gains are taxed at 15 per cent. If these funds are sold after a year, investors do not have to pay any tax as long-term capital gains tax is nil. If investments in liquid funds are sold before three years, the gains are treated as short-term gains and taxed as per the Income Tax slab applicable to the investor. If liquid funds are sold after three years, they qualify for long-term capital gains tax of 20 per cent with indexation.

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