Most of the investors keep their emergency fund in the FD or in the liquid or debt funds. Now I think from last year onwards we have to pay tax on debt fund as per our tax slab and thus making it not so good option for investing. I know we should not think about returns for the emergency fund but still we have to get some returns so that the emergency fund will keep upto date with the inflation.
So now if you are investing in Liquid Funds or FD you have to pay the tax as per your tax slab. So the next best option is Arbitrage Fund. Arbitrage fund is a low risk equity fund. Now you may ask that equity means Risky then how come it is low risk. So Arbitrage fund buys and sell equity but it does only to lock in profit in two different markets. For example, buying in the normal market and selling in the future market.
It doesn't aim for huge profit, even if it is small profit it is fine. And that's why the returns are similar to the liquid funds but it gives a major tax advantage. Since it's a equity fund you have to pay 20% short term tax if it redeemed less than a year. And you have yo pay 12.5% tax if it's over 1.25 Lakh profit only when you sell after an year I.e. long term tax. And that's the big tax advantage for the people who are parking their money on the emergency fund.
Now for example, you are investing in Arbitrage Fund and you keep it for more than 1 year. You can then take out some money and reinvest, so basically you are doing tax profit Harvesting and you are getting the full advantage of the returns. And that's why Arbitrage Fund are better than the Liquid Funds.
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