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Arbitrage Funds vs Fixed Deposits in India: Which is Better?

Posted on 26 May 2024
Author: Sayan Sircar

Tags: Mutual Funds ; Fixed Deposit

5 mins read
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This article highlights the main differences between arbitrage funds and fixed deposits in India to help investors make the best choice for their financial needs.

Arbitrage Funds vs Fixed Deposits in India: Which is Better?

This article is a part of our detailed article series on the concept of hybrid mutual funds in India. Ensure you have read the other parts here:

Should you invest in hybrid funds via SIP for short-term goals?

This article shows you how different categories of hybrid funds have performed for regular SIP investments for short durations.

Aggressive hybrid mutual funds: understanding the what, why, when and who

This article discusses mutual funds belonging to the aggressive hybrid category for investors to understand if they should invest in such funds.

A primer on hybrid mutual funds: what are they and when to invest in them

This article talks about the hybrid mutual fund category in India and shows you which ones to invest in as per your goals.

📚 Topics covered:

What are Arbitrage Funds?
How do Fixed Deposits Differ from Arbitrage Funds?
How are Arbitrage Funds Better than FDs?
How are FDs Better than Arbitrage Funds?

We have discussed this topic in general before: Mutual Fund vs Fixed Deposit - where should you invest?

What are Arbitrage Funds?

Arbitrage funds are hybrid mutual funds that capitalize on price differences between equity cash and futures markets.

These funds are taxed like equities (10% tax on long-term capital gains over ₹1 lakh), making them attractive for short-term investment. Investors should note:

Short-term gains may vary significantly based on available arbitrage opportunities. It’s wise to assess this before investing.
SEBI mandates up to 35% of the fund’s portfolio can be in debt instruments, which requires the usual debt fund due diligence.
Like all mutual funds, returns are not guaranteed, and there is a risk of not recovering the full investment.
You can invest regularly in SIP form. FDs have recurring deposit but there is lesser amount of flexibility

How do Fixed Deposits Differ from Arbitrage Funds?

Fixed deposits (FDs), unlike mutual funds:

Guarantee the return of the principal and the predetermined interest.
Provide exact figures for what you’ll receive at maturity.
Clearly state the date on which you will receive your money.

To understand whether arbitrage funds are better than FDs for you:

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Also read
What should be the Asset Allocation for your goals?

How are Arbitrage Funds Better than FDs?

Arbitrage funds offer several advantages over fixed deposits:

There is no fixed maturity date. You can invest your money and withdraw it when needed.
Taxes on capital gains are due only upon sale, whereas FDs are taxed annually and upon maturity.
Capital gains tax is lower (10% for holdings over one year; 15% for shorter periods) compared to your income tax slab, which could be as high as 30%.
You can withdraw your investment anytime after 30 days without penalties.
Arbitrage funds do not require choosing an investment duration, as FD interest rates vary based on the term length.

Arbitrage funds are suitable if you are in a high tax bracket, can manage variable returns, and prefer flexibility in building a short-term fund over guaranteed principal safety.

How are FDs Better than Arbitrage Funds?

FDs offer distinct benefits that arbitrage funds lack:

They provide fixed and guaranteed returns of both principal and interest.
They offer a sense of security as all banks are considered safe, especially SIFI banks (e.g., SBI, HDFC, ICICI).
Early withdrawal of FDs results in a loss of interest: Should you break your FD and create a new one at new higher rates?
Most FDs allow for online termination, unlike mutual funds which typically require at least one business day to process withdrawals.
FDs, especially sweep FDs, are ideal for accessing funds during emergencies.

FDs are preferred by those who prioritize safety over returns, are in lower tax brackets, and can synchronize their cash flow needs with FD maturity dates.

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