When it comes to investing fixed deposits come naturally to 90% of Indians. After we all love to have 8-9% of guaranteed returns without worrying about market fluctuations. Unfortunately this does not leads to wealth creation.It has not even been able to beat inflation. If we check inflation adjusted returns of fixed deposits post tax, it will be negative.
Sad! Isn’t it.
So what to do?
The answer is invest in equities. Ofcourse only after good research. They have over long term given a tax free return of 13-14% which is good enough to beat inflation.
Hey, But I neither have knowledge nor time to do equity research. I invested in some stocks based on advice of any expert on TV and lost 80% of my principal amount..
Humm.. Okay invest in mutual funds they are managed by experts and have given even better returns than equity over long term. Over 10 year’s period even the worst mutual fund has given better return than FD after tax deductions
No man I want fixed and guaranteed returns. It’s my hard earned money.
Hold on! Why don’t you try Arbitrage fund. They are most viable alternatives to FD and other debt funds.
Till one year back most of us had not even heard about arbitrage funds. They came to focus when govt. changed tax treatment for all debt instrument. Before we dig deep into this lets first understand what exactly arbitrage funds are. Arbitrage funds try to take advantage of the arbitrage opportunities arising out of pricing mismatch of stocks in the equity and derivative segment of the stock market. This means that market performance will have little or no impact on them. Most arbitrage funds give returns in the range of 8-9% per annum on an average.
Now the best part.
Due to their nature of transaction arbitrage funds are treated as equity funds despite the fact that their risk – return profile is similar to debt funds. This makes their tax treatment similar to equity funds which is a huge bonus for conservative investor willing to park his money for 1 year or more. There is little short term capital gain tax if redemption happens before 1 year and NO tax at all if you redeem it after 1 year. This is exactly same as equity funds.
This makes it a superior financial product in comparison to fixed deposits or even other debt funds.
For debt funds the tax structure is as below
The gain arises due to redemption of debt mutual fund within 3 year (Earlier 1 year) shall be added in the income of investor and tax will be charged at the rate according to the tax slab.
After 3 years long term gain arises from the sell/redemption of debt mutual funds shall be taxable at the rate of 20% + 3% Cess with indexation. Due to indexation the overall tax is virtually reduced to zero however for this to happen the time period is 3 years.
For fixed deposits the interest income is deducted directly by the bank as TDS subject to below conditions
1. Interest income < 10K no TDS is deducted however you need to mention the income in your tax return as income from other sources and is taxed as per your income slab.
2. Interest income > 10K TDS is deducted directly by the bank . If your PAN details are available then TDS rate is 10% else 20%.
From the above analysis it looks obvious that arbitrage funds are clear winner when it comes to investing for a conservative investor. Its return are similar to FD or debt fund but real returns are much higher due to tax exemption after one year. All you need to do is to redeem it after 1 year.