Posted on October 1, 2025. Updated on October 8, 2026
Investors seeking safe yet rewarding investment avenues often weigh options like Fixed Deposits (FDs) and Equity Arbitrage Funds. However with the changes introduced in the last Union Budget, one should now also evaluate a new category of investments called Income Arbitrage Funds. Each of these investment options comes with its own set of advantages, risks, and tax implications. To help you make an informed choice, here’s a comprehensive comparison of these three investment categories.
Fixed Deposits (FDs)
Overview:
Traditional savings instruments offered by banks and financial institutions, FDs are favoured for capital safety and assured returns. Bank deposits are insured by DICGC up to ₹5 lakh per depositor per bank; amounts above that and deposits with NBFCs or corporates carry the issuer’s credit risk.
Pros:
– Capital preservation with fixed interest payout
– Easy to understand and invest.
– Flexible tenure options.
Cons:
– Low returns relative to inflation, typically around 5-7%
– Penalties for early withdrawal (may vary by financial institution)
– Fully taxable interest, reducing net post-tax returns depending on the investor’s tax income tax bracket
Outlook:
With current bank FD interest rates around 5-7%, FDs remain a steady capital preservation investment tool albeit with low post-tax returns, especially for those in higher income tax brackets. The tax treatment of FDs makes it an inefficient choice for those in higher tax brackets, and something that us unlikely to beat inflation in the long term.
Equity Arbitrage Funds
Overview:
These are mutual fund schemes that invest in a combination of low risk debt securities (<35% of portfolio) and equity arbitrage opportunities. The equity arbitrage opportunities focus solely on exploiting price differences between the cash and equity derivative prices, and are completely hedged resulting in low volatility. However returns are market linked and not assured.
Pros:
– Low volatility
– Less market-dependent compared to pure equity investing.
– Tax benefits: Gains are taxed at 12.5% for holdings beyond 1 year on gains above ₹1.25 lakh a year; gains on units held up to 1 year are taxed at 20%.
– Low risk relative to direct equity investments.
– Arbitrage opportunities tend to increase when markets are volatile.
Cons:
– Returns can be modest and vary with arbitrage opportunities
– Can be affected by market stability; returns can fall if equity markets are stable
– Slightly higher expense ratios compared with liquid funds
Outlook:
Historically, Equity Arbitrage Funds have provided annual returns in the mid single digit bracket. Returns may fluctuate based on arbitrage opportunities and are not guaranteed.
Income Plus Arbitrage Funds
Overview:
These are funds of funds that invest in both debt funds and arbitrage funds, which use equity arbitrage opportunities in the stock and futures markets. The aim is to combine debt-fund returns with a better tax treatment than a pure debt fund for investments held more than 24 months. These funds will hold less than 65% in debt (but near it) and over 35% in arbitrage, thereby allowing them to take advantage of the recent Budget changes which provide for capital gains tax at 12.5% if the investment is held for more than 24 months, without indexation (gains within 24 months are taxed at your slab rate).
Pros:
– Since a significant part of the portfolio is in debt, any reduction in interest rates could result in additional gains
– Tax advantages: Long-term gains taxed at 12.5% (long term = when investments are held >24 months)
Cons:
– Returns may drop if interest rates rise.
– Most of these funds operate as Fund of Funds and therefore have slightly higher expense ratios compared to liquid funds
– Tax advantage only if held for more than 2 years
Outlook:
Returns are market-linked and not guaranteed. They depend on interest rates, the credit quality of the underlying debt funds and arbitrage spreads; falling interest rates can help returns and rising rates can reduce them.
These funds are gaining popularity for their combination of debt exposure and tax efficiency, making them potentially suitable for conservative investors who can stay invested for more than two years and accept some interest rate and credit risk.
Comparison of FDs vs Equity Arbitrage Funds vs Income Plus Arbitrage Funds
| Investment Option | Returns | Tax Rate | Key Risks | Remarks |
| Fixed Deposits | Fixed for the term | Fully taxable at investor’s slab rate (30% if in highest slab) | Bank credit risk above the ₹5 lakh insured limit | Suits certainty of return and short-term needs; post-tax returns can be below inflation |
| Equity Arbitrage Funds | Market-linked, not guaranteed | 12.5% capital gains tax if held for more than 1 year (on gains above ₹1.25 lakh a year); 20% if held up to 1 year | Lower returns when markets are calm | May suit conservative investors with holding period of 1 to 2 years |
| Income Plus Arbitrage Fund of Funds | Market-linked, not guaranteed | 12.5% capital gains tax if held for more than 2 years (no indexation); slab rate if held up to 2 years | Interest-rate and credit risk | May suit investors who can hold for 2 years or more |
Note: Tax treatment shown is for resident individuals for FY 2026-27 and may change; surcharge and cess apply as applicable.
Conclusion:
Choose FDs if certainty of return is your priority and you are content with potentially lower post-tax returns. These are more suitable for shorter periods.
Consider Equity Arbitrage Funds if you are in a higher tax bracket, the money is for the next year or two, and you accept that returns are not fixed.
Consider Debt-plus-Arbitrage Funds of Funds if you can remain invested for more than two years and are comfortable with some interest rate and credit risk.
Rohin Pagdiwala, Founder – Pagdiwala Investments, Mumbai
AMFI-registered Mutual Fund Distributor ARN-186203 | APMI-registered PMS Distributor APRN-00370
This article is for general information only and is not investment or tax advice. Tax rules may change from time to time; please consult a certified tax professional for your specific case. Mutual fund investments are subject to market risks, read all scheme-related documents carefully. Past performance is not an indication of future returns. Pagdiwala Investments is not a SEBI-registered Investment Adviser.