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Even liquid funds which are often suggested as an alternative to short-term FDs, have delivered a return of 4.16% (Mint)
Even liquid funds which are often suggested as an alternative to short-term FDs, have delivered a return of 4.16% (Mint)

Three products you can park a lump sum in for the short term

  • Since FDs and liquid funds are giving low returns, you can consider other products for one-three years
  • If you are looking to park your money for just six months to a year, stay with fixed deposits or liquid funds

Investors looking to park a lump sum for the short term are finding themselves in a fix, with returns from fixed deposits (FDs) and liquid funds, the preferred instruments for short-term investment, floundering.

FDs are among the most preferred instruments for short-term lump sum investments. However, FD rates are at multi-year lows currently. Currently, a one-year FD at the State Bank of India (SBI) is offering a rate of 4.90%. The post-tax returns fall further for those in the 30% tax bracket; in this case to 3.43%.

Also read: India can’t make up its mind on PSUs, 30 years after liberalisation

Even liquid funds which are often suggested as an alternative to short-term FDs, have delivered a return of 4.16% over the past one year, as per data from Value Research. As the returns from liquid funds are taxed as per the slab rate for a period of up to three years, the post-tax returns will further go down to 2.9% for those in the 30% tax bracket.

We list three instruments, which can provide better returns without compromising too much on safety. Note that it makes sense to go for them only if your have a tenure of more than a year or so.

savings account

Some banks, including IDFC First and Bandhan Bank, are offering interest rates up to 7% on their savings bank accounts. These banks don’t have the vast account base that most large commercial banks have. They, therefore, offer lucrative rates on savings and term deposits to attract potential customers to build up their current account and savings account (CASA) deposits. The post-tax return for a person in the 30% tax bracket will be 4.9%, if the savings account is offering 7%.

However, these banks generally have a higher minimum balance requirement, of at least 1 lakh, for savings accounts offering high interest rates. “This can be a good option but opening a bank account for the purpose of investment alone is a call one will need to take. Also, these banks can re-adjust their rate downwards anytime and the advantage could get lost," said Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Sebi-registered investment adviser.

These banks are regulated by the Reserve Bank of India just like any other commercial banks. But if you are doubtful about safety, given the recent crisis events at some commercial banks, remember that every bank account has a deposit insurance of up to 5 lakh. If the amount is large and you want to go for high-interest savings accounts, diversify across banks to spread the risk. So if you have 10 lakh to invest, split the amount between two banks to meet the 5 lakh deposit insurance limit in each bank.

Arbitrage funds

These are mutual funds that invest in equity and derivative instruments at the same time to benefit from the price differential. Fund managers look for arbitrage opportunities to make profit. For example, say a stock’s spot price is 100 and the derivative segment price is 110. In such a situation, the fund manager may sell the stock in the derivative market and buy it in the spot market. The profit will be the difference between derivative market and spot market prices; 10 ( 110- 100) in this case.

The benefit of investing in these funds is that they get the tax treatment of an equity fund. Although these funds have not delivered a very high return over the past one year, their post-tax returns are likely to be better than what a bank FD or liquid fund will gives. “One can look for arbitrage funds which offer better tax advantage over the FDs if your holding period is more than a year," said Basavaraj Tonagatti, a certified financial planner, fee-only planner and Sebi-registered investment adviser. After one year, the gains from these funds are classified as long-term gains and taxed at 10% over 1 lakh. This reduces the tax liability.

Over the past one year, arbitrage funds have returned 3.63%, according to data from Value Research. After a one-year holding period, returns up to 1 lakh will be tax-free; above that, the post-tax returns would come to 3.3%.

Debt fund

Planners believe that if chosen carefully, debt funds can be a good option especially if someone is looking to invest for a period of over three years. “Debt mutual funds have got a bad name after recent incidents. However, some of the funds have been able to generate 8-9% per annum over the past three years," said Lovaii Navlakhi, managing director and chief executive officer, International Money Matters, a Sebi-registered investment advisory firm.

However, choose a debt fund in sync with the investment tenure. “Short-term debt funds are probably the right fit here. One can also look at banking and PSU debt funds with an appropriate duration. In all these, be mindful of choosing funds that have high-quality underlying papers," said Sadagopan.

Short-term funds invest in debt papers with Macaulay duration of one-three years. Macaulay duration is a measure of how long it takes for the price of a bond to be repaid by the cash flows from it. If you invest for over three years, you’ll also get indexation benefit on long-term gains.

Mint take

FDs are preferred because they provide safety of capital and certainty of returns. So if you are looking to park money for just six months to a year, don’t chase higher returns and stay with FDs or liquid funds. “Please note that 1% higher return on 1 lakh investment in a year is just 1,000. Don’t risk the entire 1 lakh for a possible higher return of 1,000," said Melvin Joseph, a Sebi-registered investment adviser and founder of Finvin Financial Planners.

For higher tenures, you can consider the options listed above.

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