When it comes to short-term investments, many people get confused between liquid funds and arbitrage funds. Both options are considered relatively low-risk compared to pure equity funds, and both are popular among investors looking for better returns than a savings account. However, they differ in terms of how they work, the kind of returns they offer, how liquid they are, and what risks they carry.

This blog will break down both of these mutual fund types in a simple way. Whether you’re just starting to invest or trying to park your idle money smartly, this guide will help you choose the right fit for your goals. You can also use a SIP calculator to plan your investments in either option.

What Exactly is an Arbitrage Fund?

An arbitrage fund is a type of mutual fund that aims to make profits from price differences in the stock market. It buys a stock in the cash market and sells it in the futures market when there’s a price difference between the two. This technique is known as arbitrage.

The fund earns from this difference and is considered low-risk because both buying and selling are done simultaneously, locking in the profit.

Key Points:

• Treated as equity-oriented for tax purposes.
• Suitable for investors with a low to moderate risk appetite.
• Ideal for short to medium-term holding.

So, what is a Liquid Fund, Then?

A liquid fund is a type of debt mutual fund that invests in very short-term money market instruments like commercial papers, treasury bills, and certificates of deposit. These instruments have high credit ratings and mature in up to 91 days.

Liquid funds aim to provide better returns than regular savings accounts while keeping risk and volatility minimal.

Key Points:

• Extremely short investment horizon (even a few days).
• Usually allows quick withdrawals.
• Generally offers stable, low-risk returns.

Arbitrage Funds: The Good and The Not-So-Good

Let’s look at some of the strengths and limitations of arbitrage funds:

Pros:

• Low risk compared to regular equity funds.
• Tax-efficient if held for more than 1 year.
• Suitable for short-term parking with slightly higher return potential.

Cons:

• Returns depend on the availability of arbitrage opportunities.
• Can be less predictable in very stable markets.
• Redemption can take 2-3 working days.

Liquid Funds: Benefits and Limitations You Should Know

Here’s a quick look at what makes liquid funds popular and where they may not be ideal:

Pros:

• Very low risk due to high-quality short-term instruments.
• Money can be withdrawn in 24 hours (in most cases).
• Suitable for emergency funds or short-term savings.

Cons:

• Returns may be lower than arbitrage funds in bullish markets.
• Still carries some interest rate and credit risk (though minimal).
• Taxed as per debt fund norms.

Arbitrage vs Liquid Funds: A Clear Comparison

Let’s compare arbitrage funds and liquid funds on some key factors:

If you’re unsure about how your investment could grow, try using a SIP calculator. It helps you estimate returns based on your monthly contribution and investment duration for either fund type.

Which One Should You Pick: Arbitrage or Liquid Fund?

Both arbitrage funds and liquid funds serve different needs, so the right choice depends on your specific goals:

Choose the Arbitrage Fund if:

• You want better post-tax returns over a period of 6 months to 1 year.
• You’re comfortable with a 2–3 day redemption time.
• You’re okay with minor fluctuations in returns.
• You’re looking for a low-risk way to enter equity markets.

Choose Liquid Fund if:

• You need very quick access to your money.
• You want to park idle money for a few days to a few months.
• You want extremely low risk and predictable returns.
• You’re building an emergency fund.

If you have multiple short-term financial goals, you can even use both funds together—liquid funds for instant needs and arbitrage funds for slightly better returns on short-term surplus.

Wrapping It Up

In the debate between arbitrage funds and liquid funds, there is no one-size-fits-all answer. Arbitrage funds give slightly better returns when the market is volatile, while liquid funds offer safer and faster access to your money. Both are good alternatives to letting your money sit idle in a regular savings account.

Just remember: align your choice with your financial goals, liquidity needs, and tax preferences. And before you invest, try out a SIP calculator to set realistic expectations and track your growth.