Liquid funds are generally used by investors to park their emergency corpus. Liquid funds invest in money market instruments with a maturity of 91 days. These funds are generally accessible within T + 1 days
Is it worth going back to traditional investment instruments?
Double-digit returns from debt mutual funds have declined over the past year. The year-over-year yields on liquid funds and overnight funds actually fell 3 percent below the interest offered by banks on savings accounts. In such a scenario, some mutual fund investors are looking at the option of switching to bank FDs for slightly higher returns on their short-term investments. But is it worth going back to traditional investment instruments? Or is there a better option to invest your money for a short time?
Since 2019, the RBI has sharply cut the policy rate (250 bps) and announced a series of measures to support the economic downturn linked to COVID, which has reduced returns on short-term debt funds over the past year. past year.
“The measures announced as well as the abundance of liquidity in the banking system have caused yields to fall across the entire yield curve, especially at the short end. This sharp decline is also reflected in the yield to maturity of funds on the shorter duration spectrum, ”said Dhaval Kapadia, Director – Managed Portfolios, Morningstar Investment Adviser India.
Liquid funds are generally used by investors to park their emergency corpus. Liquid funds invest in money market instruments with a maturity of 91 days. These funds are generally accessible within T + 1 days.
Liquid funds, a better option to park the emergency fund
FD banks for up to six months offer slightly higher returns of around 4%, which may look attractive at the moment compared to liquid funds. But mutual fund experts still favor liquid funds in terms of liquidity and after-tax reporting. They say after-tax returns on very short-lived FDs (
“Unlike bank FDs, liquid funds are not locked in and are more tax efficient in the long run,” says Priti Rathi Gupta, founder of LXME. Rathi explains, a fixed deposit is taxed annually on interest received while tax is payable on liquid mutual funds only when selling their shares and realizing capital gains. In the event that the emergency fund remains unused for a long time, investors will appreciate a lower taxation of liquid or demand funds upon redemption after three years.
Long-term capital gains on loan funds are taxed at a flat rate of 20 percent after indexation. Whereas, in the case of an FD bank, long-term capital gains will be taxed at the applicable income tax slab rate.
Short-term capital gains in the case of a FD bank or debt fund are added to the investor’s income and taxed at the applicable tranche rate.
Look at the real rate of return
Mutual fund managers urge investors to look at the real rate of return on their investments. They believe that comparing historical returns will not allow investors to invest. We should not anchor ourselves to historical returns, they say.
“Twenty years ago, when liquid funds were 8-9 percent, even inflation was 9-10 percent. So my real return was zero. Even today, when liquid funds are 3 or 3 percent. 4 percent, bond funds give 5%, inflation is 4%. As an investor, we have to learn to look at our real rate of return. Net return from inflation is what we earn, “says Kalpen Parekh, President of DSP Mutual Fund.
According to Kalpen Parekh, in fixed income, if you are able to stay 1 to 2 percent positive on inflation, it should be good for investors to look ahead.
Arbitrage Funds: an alternative to liquid funds
As an alternative to liquid funds, if you have a three to six month time horizon, mutual fund experts ask investors to consider investing in arbitrage funds. These funds typically buy stocks and sell an equivalent value in futures contracts on the respective stocks purchased. As all equity positions are fully hedged, market risk is largely eliminated. Arbitrage funds rank compared to liquid funds in terms of taxation.
“Arbitrage funds are classified as equity for tax purposes,” explains Dhaval Kapadia. According to him, the returns of these funds would be similar to those of liquid funds, but since the taxation of stocks is applicable, the after-tax returns would tend to be higher compared to liquid funds, especially for investors taxed at 20. % or more. rates.
While short-term capital gains in loan funds are taxed at the applicable investor’s tax rate, short-term capital gains in stocks are taxed at 15 percent.
According to Kalpen Parekh, arbitrage funds are a proxy for a one to two month investment with better tax efficiency.
Arbitrage funds over the past year have yielded an average return of almost 3%.
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