Liquid Funds or Arbitrage Funds| There are many ways to invest to build a wealth base. Arbitrage and liquid funds are also good ways to invest your money and make it grow. In this article, we’ll learn more about these two ways to invest.
How do arbitrage funds work?
Arbitrage funds are just a term for when investors buy securities on the cash equities market for less money and sell them on the futures or derivatives market for more money.
This means that people are buying and selling at the same time. Arbitrage funds use new opportunities in the market to make money. Tax laws say that these funds must have at least 65% of their assets in stocks in order to be called Arbitrage funds.
How to find funds that use arbitrage?
There are a few things you should know about arbitrage funds.
Arbitrage funds are bought and sold on stock exchanges, so there is no counterparty risk. Shares are bought and sold on the cash and futures markets, so there is no direct exposure to stocks.
Arbitrage funds are known for giving decent returns, but investors can only make money from them if they know how they work. For alpha to be made, the fund manager keeps an eye on price differences. In the past, arbitrage funds have given returns of between 7% and 8% over a period of five to ten years.
Arbitrage funds are expensive because they have to pay a lot to make trades. The fund manager also charges an exit load to make investors less likely to sell their shares. All of these things cause the fund’s expense ratio to go up. If the expense ratio is high, investors will get less money back in real terms.
investment time frame
Arbitrage funds are good for investors who want to make money in the short- to medium term (3 to 5 years). Since these funds charge a high exit load, investors should only put money into them if they plan to stay for at least 6 months.
These funds are taxed the same way as equity funds. Without indexation, the tax rate on short-term capital gains is 15%, while the tax rate on long-term capital gains is 10%.
How do liquid funds work?
Debt funds are the group that includes liquid funds. These funds buy money market instruments like treasury bills, commercial papers, certificates of deposits, etc.
Because these are money market instruments, they will usually be paid off in 91 days.
How to find funds that are liquid?
Here are some things you should know about liquid funds:
- Highly liquid
Liquid funds give investors a high level of liquidity and capital safety because they invest in high-rated debt instruments that will be due in only 91 days.
People put their money into these funds to reach their short-term financial goals.
2. Less vulnerable
Since these are fixed-income funds with a 3-month portfolio maturity, they are not affected by changes in interest rates. So, the NAV of these funds doesn’t change a lot.
It is known that liquid funds have made between 7% and 9%, which is more than the interest rate on a savings account. But the rates of return depend a lot on how liquid the funds are on the money market and in interbank deposits.
Interest rates go down when there are a lot of loans on the market with low-interest rates and up when there are a lot of loans on the market with longer terms.
4. Low risk
Since liquid funds invest in money market instruments that are very liquid, these are considered low-risk investments. The fact that liquid funds don’t have a lock-in period is another good reason to choose them.
After being added to your total income, short-term capital gains are taxed at the rate of your income bracket. After indexation, the tax rate on long-term capital gains is 20%.
Liquid funds are taxed the same way as any other debt funds.
Which one should I pick?
Investors should know that the returns on Arbitrage funds are very unstable because the prices change based on what happens in the stock market and the futures market. So, if an investor wants to choose Arbitrage funds, he should invest in them with a lump sum rather than with SIPs.
Over the same time period, liquid funds give better returns than arbitrage funds. The table below shows how 1 year rolls over from the table that comes back for 3 years. From the table, it was obvious that liquid funds did better than Arbitrage funds.
The table shows that 79% of the time, liquid funds were able to earn more than 6.5%, but only 33% of the time for arbitrage funds.
Arbitrage funds change a lot, so investors with short-term financial goals shouldn’t put their money into them. On the other hand, liquid funds are good at giving investors the cash they need to meet short-term financial goals. Liquid funds are safe and give better returns than arbitrage funds.
However, arbitrage funds are best for people who are willing to take risks and have a good financial expert who can time when to get out of and get into the stock and futures markets.
Note that there is no guarantee that liquid funds will make money, but in the past, they have done better than arbitrage funds. If investors want a mix of stocks and bonds in their portfolio, they can include arbitrage funds as long as they keep a close eye on the market.
It seems like trading with arbitrage funds is easy, but the faster opportunities come up, the faster they go away, so you have to be very active with arbitrage funds. The money you put into liquid funds is safe and grows with less risk.
Investors can choose based on their own financial goals and how much risk they are willing to take.
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