I have to invest Rs 6.5 lakhs in equity mutual funds for the long term. I understand that best way to do this is by investing a lumpsum in a liquid/ultra short term debt fund and then moving it to the equity fund through a systematic transfer plan, or STP.
Considering the STCG, is it advisable to follow this approach? I am already earning 6% interest in my bank account.
Which are the best liquid/ultra short term debt funds where I can park the money and then transfer it?
- Puneet
You are correct. STP allows an investor to park a lumpsum amount in mutual funds, like you rightly mentioned - liquid and ultra-short term, arbitrage or other funds with low risk investment strategies. From there the money can be gradually shifted into another fund with a long-term investment objective, for example, an equity fund.
This facility helps an investor to benefit from rupee-cost averaging, i.e., buying more units when the net asset value, or NAV, is low and less units when the NAV is high. It provides a consistent flow and helps one save efforts of trying to time the market.
For taxation, arbitrage funds are treated as equity and applicable Short-Term Capital Gains (STCG) tax rate for units held for less than 1 year is 15%. STCG applicable for liquid / ultra-short-term debt funds / interest from savings account is as per the investors tax bracket. Assuming that the investor is in the highest tax bracket, the tax treatment for arbitrage funds is favorable vis-à-vis Liquid / UST funds, interest from savings account.
In terms of liquidity, arbitrage funds carry exit loads for exit up to 1 month or so (some funds may have loads for longer periods). Due to their return characteristics, market neutral nature and liquidity provisions, arbitrage funds are considered debt-like, acting as substitutes for savings accounts, liquid and ultra-short term debt funds. From a taxation perspective, STP from arbitrage funds in to equity funds would be more beneficial after considering taxation.
To evaluate mutual funds across categories, one can look at Morningstar’s star ratings and analyst ratings for screening mutual funds. Use this screener.
Do consult a financial adviser before making investment in mutual funds.
