As mutual fund (MF) investments – especially in equity-oriented funds – are subject to market risks, it is advised never to invest the money that you may need at a short notice in MF schemes.
Why long term
To avail the benefits of equity investments, you should be prepared to face market volatilities – especially in the short term – and invest only that part of money that you may spare for the long term, so that you may stay invested during the low-market cycles and get a higher return by redeeming your investment during a high-market cycle.
As ups and downs are the innate nature of equity markets, to determine at which upcycle you should redeem, it’s better to enter markets after doing a proper financial planning, so that you can redeem during an up cycle close to a financial goal.
Where to invest for short term
To invest in a mutual fund for a short term, you should go for a suitable debt-oriented fund. At least 65 per cent of investments of such funds are made in debt and debt-related instruments. As a result, such funds become relatively stable due to low or no equity exposure.
However, to avail the tax benefits of long-term investments, an investor needs to stay invested for at least three years in a debt fund.
How to avail tax benefits by investing for a shorter period
As the holding period for availing long-term tax benefits for equity funds is 1 year, you have to invest in an equity-oriented fund for the benefit.
Which equity fund?
To avail the tax benefit of an equity fund for a short term investment, you may consider investing in an arbitrage fund, which falls under the hybrid fund category. Such funds aim to provide benefits from arbitrage opportunities in securities in the shape of price differences between markets.
These funds achieve this by simultaneously buying stocks in the cash market and selling them in the futures market, earning a gain because of the difference. As the price differences between markets are in a small range, the returns on arbitrage funds are also low, but consistent.
Why to invest in an arbitrage fund?
Lower volatility and risk: Since equal and simultaneous positions are taken in cash and futures, there is low risk from share price fluctuations.
Tax friendly: Being equity-oriented, they are more tax-friendly than debt funds.
All weather fund: Since arbitrage opportunities are available across market phases, investors can invest in them regardless of market conditions.
So, the sole advantage in investing in an arbitrage fund over a debt fund is the shorter holding period to get tax benefits.