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You need to save and invest for the future but making sound investments is no easy task. Investing in different types of funds offers many benefits such as liquidity or long-term security. But you must understand your financial needs to do so while involving minimal risks. You might choose to invest money in fixed deposits that allow high returns without involving a high risk. Arbitrage funds however involve comparatively more risk and may offer equivalent or lower returns. Here is a comparison of Arbitrage Fund vs FD to help you make wiser investment decisions.

What is an Arbitrage Fund?

Arbitrage funds work by taking advantage of the mispricing in equity shares between current and future markets. The fund manager will enter into simultaneous buy-and-sell transactions to generate maximum returns on these differences. It involves buying stocks from a cash market and selling them for futures or derivatives at higher prices. This requires continuous monitoring but successful transactions lead to substantial profits with little risk. The fund managers notice stock price changes across exchanges. They try to buy stocks at low prices and simultaneously sell them at higher prices. This helps them generate returns by buying cheaper and selling expensive. 

What is Fixed Deposit (FD)?

Fixed deposits(FDs) are term based investment instruments that banks and non-banking financial companies (NBFC) offer their customers. Through a fixed deposit, you invest a certain sum of money for a predetermined period at a prescribed interest rate. The rate of interest set by the bank or NBFC is usually higher than savings account rates. However, it can vary from one institution to another depending on the tenure and amount of funds. The best part about these investments is they provide great returns in comparison to other low-yield instruments like bonds. They do not involve any risk and you don’t lose the value of your money over time. To enjoy low risk and high returns you must hold the funds in FD till the maturity date. You can hold a fixed deposit for the period that suits you. It can range from short-term tenures such as 7 days to long tenure ranging up to 10 years. The interest rates for each duration will vary for different institutions.

Difference Between Arbitrage Fund and FD

We can compare Arbitrage Fund vs FD based on the following factors:

  • Risk – Arbitrage funds are risky in comparison with Fixed Deposits. The Deposit Insurance and Credit Guarantee Corporation (DICGC) offers insurance up to Rs. 5 lakhs. You should make use of this insurance scheme when investing in a fixed deposits plan.
  • Returns – In fixed deposits, you get the pre-declared assured returns. In Arbitrage funds, the returns are dependent on the market. Unlike FD these funds do not assure fixed returns.
  • Tax – The interest on a fixed deposit is taxable in the hands of the investor. In tax-saving fixed deposits, there is no tax benefit for the interest earned and reinvested under Section 80C. The exemption is applicable only on the principal amount. In an Arbitrage fund, there are two types of taxation. First is Long term capital gains (LTCG) which is chargeable at 10% for holdings above one year. The second one is Short term capital gains (STCG), i.e. 15%.
  • TDS Deduction –  In a fixed deposit, TDS is deducted at the rate of 10% over the interest amount. This deduction is applicable if your interest income exceeds Rs 40,000. In the case of senior citizens, the interest amount must exceed Rs. 50,000 for TDS deduction. Whereas, there is no TDS deduction in the Arbitrage fund. 
  • Premature Withdrawal – In both Arbitrage funds and FD you have to pay a penalty if you withdraw early. Arbitrage funds may levy exit load if you redeem within 30 days or 60 days of purchase. Whereas fixed deposit investors are liable to a penalty on premature withdrawal which depends on banks.

Arbitrage Fund vs FD – Which is a Better Investment Option?

You can choose from two kinds of investment instruments to streamline your investments. You must identify your needs and compare arbitrage funds vs fixed deposits. An arbitrage fund offers high interest rates. But it is risky during volatile markets and there is no guarantee of returns. A fixed deposit provides investors with higher interest returns until the maturity date. However,  you may have to pay a penalty for early withdrawals depending on the depositing entity.

You may also check out for Liquid Funds vs Fixed Deposits