Mutual Funds To Generate Greater Returns Than Bank FDs

Apparently investing in bank fixed deposits (FDs) is best way to park your money for an investment horizon of two years. It is because equity mutual funds (MFs) are meant for long-term investments and 2-year period is too risky for investing the money that you need at the end of the period. Moreover, you will get the indexation benefit only after three years on debt mutual funds, which are meant for short- and medium-term investments.

Bank FDs are considered safe and give similar return generated by debt MFs. Apart from higher liquidity, the only other advantage of debt MFs over FDs is indexation benefits on long-term capital gain (LTCG). After indexation, the taxable return on debt FDs reduce drastically, making the tax payable much lower than that of FDs. So, the investors gain by saving taxes on debt MFs, while getting similar returns of bank FDs.

But the return on debt MFs are considered LTCG only when such funds are redeemed after three years from the date of investments. Otherwise, on any gains up to three years, there would be no significant difference in return and taxation among debt MFs and bank FDs, apart from the fact that TDS is applicable on FD interests, while capital gain tax triggers only on redemption of debt MFs.

So, the question remains, if it is not even debt Mutual Funds, what would give you better return than bank FDs in an investment for two years? For better return, you may try an Arbitrage Fund, which is a type of equity mutual fund that takes advantage of the differences in prices of securities in the cash and derivatives market to generate a return. Such price differences occur when markets are volatile and cash or derivatives lags behind the other to react on market fluctuations.

As such transactions are done on real time basis, arbitrage funds are are considered tailor-made for risk-averse investors and are a relatively safer option to park money. The gains on arbitrage funds would be higher when there is a persistent volatility in the market, as the higher and frequent market fluctuations would cause more price differences, providing greater opportunity for fund manages to transact and generate returns for investors.

As a part of equity MF category, returns on arbitrage funds also enjoy the tax benefits of equity investments and any return generated on redemption made after one year from the date of investment would be treated as LTCG.

So, you may have to pay no tax on returns generated by an arbitrage fund by redeeming it after two years from the date of investment as LTCG on arbitrage funds are tax free up to Rs 1 lakh, while the interest of FDs are fully taxable.