Liquid vs Arbitrage mutual funds: Which one should you choose for short-term investments?

Liquid vs Arbitrage Mutual Funds: Both liquid funds and arbitrage are regarded as low-risk mutual fund choices for parking short-term money. But they differ greatly in terms of taxation, liquidity, and investment.

Arbitrage Funds

Arbitrage funds are a type of hybrid mutual fund that aim to profit from temporary price differences of the same asset in two different markets, usually the cash (spot) market and the futures market.

Short-Term Capital Gains (STCG) on investments held for less than a year are taxed at a flat rate of 15%.

Long-Term Capital Gains (LTCG) on investments held for more than a year are taxed at 12.5% on gains exceeding ₹1.25 lakh per financial year.

⦁ Those who want to earn tax-efficient returns.

⦁ Don’t need instant access to the money (since arbitrage funds usually have an exit load)

⦁ Are okay with short-term market-linked fluctuations (very minimal risk).

Liquid Funds

**Suitable for **

⦁ Investors who will need money in the next few weeks/months.

⦁ Investors who prefer very low risk and high liquidity.

⦁ Not focused on high returns, but more on safety and accessibility.

Arbitrage vs Liquid funds: Which is suitable for whom?

"A part of your emergency fund should be invested in arbitrage funds," said Balwant Jain. "These funds come with equity-like taxation, which offers a significant tax advantage. You can redeem up to ₹1.25 lakh in gains every year tax-free and then reinvest the amount, although an exit load may apply if redeemed within a short period. This makes arbitrage funds a smart choice for those looking to optimise returns with minimal tax impact."

"On the other hand, liquid funds are better suited for those seeking regular income or looking to temporarily park surplus money. While the returns may not be high, liquid funds offer high liquidity and are ideal for conservative investors or those with short-term financial needs," he added.