If you’ve booked profits from your investment or trading activities in the stock market, where should you park this money? You may be looking for temporary parking grounds for this money, from which you can redeploy money into equities when opportunity knocks again. If this is your requirement, you will need products that protect your capital, offer easy liquidity and deliver reasonable post-tax returns.
Bank FDs
Bank fixed deposits, may seem like the obvious choice for parking temporary money. But choosing the right tenor is the challenge. Most banks offer attractive FD rates, going up to 7.5-8 per cent for 1 to 3-year terms, but rates are anaemic, for less than one year, at 3.5 to 6.5 per cent. As interest is taxed at slab rates, the returns for short-term FDs work out to just 2.5-4.5 per cent at the 30 per cent tax slab.
As you may need the money before maturity, you will need to factor in the bank’s rules on early withdrawal. Some banks actually prohibit premature withdrawal on high-value deposits of ₹2 crore or more. But with most banks, if you pull out early, you get the rate applicable for the actual period of deposit and not at a contracted rate. You may pay a premature withdrawal penalty of 1 per cent. All this can substantially trim your returns, even if bank FDs make the cut on safety and liquidity. This may prompt you to look at some unconventional options outside them.
Money market funds
If you have a large sum to park and capital safety is your priority, there can be no better short-term investment than Treasury Bills from the Government of India. Currently, T-Bills also offer better returns than bank FDs. In the RBI Retail Direct platform, you can bid and invest in 91-day, 182-day and 364-day, T-Bill auctions which are quite frequent and offer yields of 7.04-7.18 per cent. After taxation at slab rates, returns work out to about 5 per cent. T-Bills do not offer anytime-liquidity and you may need to wait for maturity to withdraw.
Money market mutual funds, which are open-end funds investing in T-Bills, help you get around the liquidity problem. They offer redemption at anytime. Their returns reflect prevailing T-Bill yields and net expense ratios of 0.13 to 0.23 per cent. While returns from money market funds are taxed at slab rates, the tax does not kick in unless you redeem your units.
Overnight funds
Overnight funds are debt funds that invest in overnight reverse repos, collateralised borrowing and lending options and other money market securities that mature in a day. These funds can carry slightly higher credit risk than money market funds, as they can invest in instruments from companies and financial institutions backed by a collateral.
When tight liquidity conditions prevail in the debt market, as they do now, overnight funds can earn returns of 6.5-7 per cent. Currently, these funds carry a yield-to-maturity of 6.6-7.2 per cent. Their expense ratios, at between 0.05 per cent and 0.2 per cent, are typically lower than money market funds. Taxation and liquidity are similar to money market funds.
One-day rate ETF
In an open-end fund, after you place a redemption request, the money can take three to four days to reach your bank account. Liquid Exchange Traded Funds and One-Day Rate ETFs enable quicker withdrawals, in line with the stock settlement cycle. These funds, track overnight rates in the market and let you buy or sell units on the exchanges. The units can be pledged for broker margins too.
While many fund houses offer ETFs tracking the 1-Day Rate, most of them distribute income on a daily or weekly basis. This adds to the units held, keeping your NAV constant. The distribution, however, attracts TDS at 10 per cent and is taxable at your slab rate. Zerodha Mutual Fund, recently launched a Nifty 1 Day Rate Liquid ETF that accumulates returns in a growth option. Returns are taxable only on selling the ETF units and slab rates. But, returns are likely to be lower than money market funds, with portfolio returns of 6-6.5 per cent adjusted for the expense ratio of 0.23 per cent.
Arbitrage funds
While all of the debt options mentioned above, are taxable at slab rates, arbitrage funds score, by enjoying equity taxation. Their returns are taxable on withdrawal at 15 per cent, if you hold them for less than a year and at 10 per cent, if you have a longer holding period.
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Arbitrage funds generate debt-like returns, by trading on the spread between the cash and futures market. Their returns do not depend on market direction, but spreads can widen or contract, depending on market conditions. In terms of safety, they rank slightly lower than overnight funds. Currently, arbitrage funds carry portfolio yields of 6.8 to 7.8 per cent, with expense ratios of 0.15-0.5 per cent. Being open-ended, they offer anytime redemption, but the money can take three to four days to get credited in your account depending on the policies of the fund.