Whenever we reach close to goals, it’s always recommended to shift the investment from risky avenues to safer options. In this post we talk about which is the best option to park your money if you investment horizon is less than 6 months.
Options to Park Money for Very Short Term
1.Saving Bank Account – You can keep the money in savings bank account. The interest offered is 4% to 7% depending on bank to bank and the account balance.
Taxation – Interest up to Rs 10,000 is exempted from tax. Any additional amount is added to the income and taxed at marginal tax rate.
2.Bank Fixed deposit – You can do short term fixed deposit. Most banks offer fixed deposits from 7 days on wards. The interest offered is 6.5% to 8% for 90 days deposit and 7% to 8.5% for deposit up to 180 days. Also many banks do not offer increased rates for senior citizens for deposit of less than 1 year.
Taxation – the interest received is added to the income and taxed at marginal tax rates.
3.Debt Mutual Funds – You can choose either Liquid Funds or FMPs. The returns of both are close if compared for short term. The annual returns for the last 3 years have been in the range of 7.5% to 10%.
Taxation – the gains made on redemption within 3 years of investment is termed as short term capital gains. The gains are added to the income and taxed at marginal tax rates.
4.Arbitrage Mutual Funds – These funds leverage arbitrage opportunities in stock market to generate returns. As they are primarily invested in equities, they are treated as equity funds. The returns are similar to Debt Mutual Funds. The annual returns for the last 3 years have been in the range of 8% to 9.5%.
Taxation – the gains made on redemption within 1 years of investment is termed as short term capital gains. The gains are taxed at 15%+3% education cess (=15.45%).
So if you compare the taxation part, the saving bank account gets the most favorable tax treatment followed by Arbitrage Mutual Funds. Debt Mutual Funds and Fixed Deposits have the same taxation.
Comparison: Saving Account, FD, Arbitrage & Debt MFs
The table below compares the above 4 instruments on different parameters:
Returns after Tax:
The table below shows the returns at different tax slabs when you invest Rs. 1 lakh and Rs. 5 Lakh for 3 months and 6 months.
The cells with best returns are shaded in green.
- The arbitrage fund gives the best returns for people in higher tax bracket of 20% or more. This is because Arbitrage Funds are taxed at 15.45%
- The debt funds have the potential to give the best returns for investors in lower tax slab or whose income is below taxable limit.
- Savings bank account offering higher interest rates can be better option than investing in Fixed deposits especially for people in higher tax bracket. However as the amount invested goes up the advantage of saving account in terms of tax treatment is reduced.
- In the short term (for 90/180 days) liquid funds and arbitrage funds have the potential to offer superior absolute returns as compared to fixed deposits. On longer duration (for more than 1 year) the returns for debt mutual funds and fixed deposits are comparable.
- There are also FMPs of 90 and 180 days duration. You can invest in them if you are sure that you do not need money before maturity.
- As mentioned, go for fixed deposit or saving bank account if you want 100% guaranteed returns. Though rare but there have been instances when Debt Mutual Funds (on July 16, 2013) have given negative returns for few days. Also in case of Arbitrage Mutual Funds, there have been cases of marginal negative returns even in a quarter. For e.g. – JM Arbitrage Advantage Fund gave negative 0.88 returns for July 07, 2008 to Oct 06, 2008 quarter.
- If you withdraw before maturity from Fixed Deposits, there would be penalty for that. So be careful to match investment duration with Fixed Deposit tenure.
- Look out for exit loads in case of mutual funds. Some liquid/ arbitrage funds charge exit load of 0.25% to 0.5% if you exit the fund within 7/90/180 days of investment. So match your investment duration and exit load timing.
- If you invest direct in Mutual Funds you can expect 0.2% to 0.5% extra returns on an annualized basis. It does not hurt to get extra returns but you may have to do a little extra work for that.
- The advantage of investing in arbitrage fund is in case you did not need money in the short term and keep it invested for more than 1 year, the entire return would be tax free.
The decision to park very short term money can be done based on your liquidity needs, amount to be parked, potential of returns, taxes and risk tolerance.
If you are not very finance savvy and are in the higher tax bracket (of 20% or more), the best option would be to get a saving account with Yes bank which offers the highest interest rate on savings account and keep money there.
But if you can take the pain to invest in arbitrage funds or liquid funds or FMPs, you would not be disappointed by the gains. The first time investment might be a bit taxing due to KYC formalities but subsequent transactions can be done easily through internet. Also the redemption request can be placed from internet.
So go ahead and do your calculations on finding the best short term investment for you.