Arbitrage funds, we all know, provide a good place to park your funds temporarily. They are treated like Equity Funds for tax purposes and they are as safe as liquid / debt funds.
Is there any issue in parking some money (typically for emergency purposes) in Arbitrage funds?
Answer is Yes perhaps. If what you have parked is more than just for emergency, meaning a sizable amount and you earn only about 7% in these funds then are you utilizing the funds the best possible way? Maybe not.
There are debt mutual funds which give about 9.5 to 10% returns. Even if you are in the 30% bracket, the net returns post tax will be about 6.7% to 7%. And some of them are very liquid meaning there is no exit load.
Let's assume we need a maximum emergency fund of Rs 100,000. And if we have 2.5 lacs (=250,000) parked in arbitrage funds, why don't we move the excess Rs150,000 into a good debt fund.
Ideally we should avoid having exposure to debt and equity funds. We could instead invest the money in balanced funds (which will have 35% exposure to debt funds) and in pure debt funds in order to further reduce equity exposure from 65% if we are conservative by nature. If we are aggressive, we could have a mix of balanced and equity funds. But investing in equity funds and in debt funds does not make much sense. Why is this so? Because of the tax implication when you redeem (sell) your debt funds.
Having said that, in the current context where we have some surplus funds in arbitrage funds I would not recommend moving the surplus to equity funds or even to balanced funds. The Sensex P/E ratio is currently about 22.6 (from the the Sensex site) and I do not think it's a great time to move our hard earned money into equity oriented funds, definitely not as a lump sum.
P/E or price/earnings ratio is one way to judge whether the prices are too high. Sensex P/E is calculated by taking the ratio of the total current market cap of all Sensex stocks and the total of the net profits of the same stocks for the last 4 quarters.
So why don't we move some of the funds that are in excess of emergency funds to debt funds like UTI Short Term Plan which does not have an exit load and gives a return of about 9.5%? Other funds such as Birla SL Medium Term Plan, L and T Short Term Income Fund which have no exit load after 1 year. Unfortunately funds such as SBI Corporate Bond Fund and HDFC Corporate Debt Opportunities Fund have a stiff exit load of about 2% each if redeemed within a year. All these funds give a return of 9.5% or more.
Of course one could look at well performing liquid funds (these do not have any exit load) and see if you are better off with those than with the ones I mentioned in this post. Most liquid funds seem to give about 8% or less.
Of course one could look at well performing liquid funds (these do not have any exit load) and see if you are better off with those than with the ones I mentioned in this post. Most liquid funds seem to give about 8% or less.
And finally remember one thing. While you may be happy getting a 9.5% return (though this is not assured), you may need to provision 20-30% of this return for income tax in case you redeem before 3 years. After 3 years, the tax may be lower.
The rule is:
Invest in If you will redeem them within
Arbitrage funds 1 years
Debt funds 1-5 years
Equity or balanced funds more than 5 years
This also means if you park in debt funds for 7 years it's silly. You can get much higher returns in a good equity fund with very less risk. Similarly if you park in arbitrage funds for 2 years it's silly. Investing in PPF, LIC etc does not make sense. Use LIC only for insurance purpose, never for investment. PPF does not make sense because you get 8.5% over 15 years. ELSS funds give the same tax advantage, at the time of writing, and gives you much higher return with very low risk for the said time frame.
PPF is a good option to invest low amounts (for example, Rs 1000 each year) for 12 years and maximize investment in the last 3 years where you get assured 8-8.5% annual plus tax savings.
Disclaimer:
I do not own any of the AMC's mentioned here nor am I the asset manager of the schemes mentioned.
Additional reading:
- http://vbala99.blogspot.com/2011/01/pe-ratio-for-stock-market-index.html
- https://www.valueresearchonline.com/story/h2_storyview.asp?str=31431&&utm_medium=vro.in - transfer of units in case of either or survivor
- https://economictimes.indiatimes.com/mf/analysis/how-does-joint-holding-in-mutual-funds-work/articleshow/56331738.cms?utm_source=AMPusers&utm_medium=emailshare&utm_campaign=socialsharebutton&from=mdr
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