Arbitrage Fund vs FD:
Post-Tax Returns Compared

The comparison between arbitrage funds and FDs is entirely a tax story. Pre-tax returns are broadly the same - typically 6.5% to 7.5% for both. The difference is how the government taxes each instrument, and for anyone in the 20% or 30% tax bracket, that difference is substantial enough to matter every year.

1. The FD Tax Problem: Your 7% Is Not 7%

FD interest is taxed as "income from other sources" - added directly to your gross total income and taxed at your applicable slab rate. There is no holding period benefit, no exemption limit, no LTCG treatment. One year or ten years: same tax rate.

The 30% slab investor keeps only 4.82% of a 7% FD - well below the estimated 6% inflation rate. In real terms, an FD at 30% slab is destroying purchasing power. This is why FDs are a tax trap for high-income investors, not a wealth-building tool. Our guide on why FDs fail to beat inflation covers this in detail. Not sure which tax slab you're in? Use our Income Tax Calculator. To calculate the exact post-tax maturity amount and TDS deducted on your FD, use our FD calculator with tax slab selector.

The FD tax problem compounds silently. At 30% slab, 31.2% of every rupee of FD interest disappears before you can invest it. Over 5 years, the compounding loss is significant: ₹10L in FD at 7% for 5 years at 31.2% tax produces ₹12.58L post-tax corpus. The same ₹10L in arbitrage fund at 7% for 5 years (LTCG at 12.5% only on cumulative gains above ₹1.25L) produces approximately ₹13.47L , a ₹89,000 difference entirely from tax treatment. The underlying returns are identical. The only variable is taxation. This 2.1% annual post-tax return gap is the sole reason arbitrage funds exist as a category , they offer FD-equivalent risk with equity-equivalent tax treatment, because SEBI classifies them as equity funds despite their near-zero market risk. Use the FD Calculator to see your FD corpus, then compare with the Mutual Fund Tax Calculator at the same pre-tax return to quantify the tax saving.

2. How Arbitrage Funds Work: The Spot-Futures Spread

Arbitrage funds do not take directional market bets. They exploit a structural pricing difference that always exists between the cash (spot) market and the futures market for the same stock. Here's the mechanics with real numbers.

The fund does this across dozens of stocks simultaneously. Because both legs (buy spot, sell futures) are executed simultaneously, the profit is locked regardless of where the market goes. This is why arbitrage fund NAV barely fluctuates - there is no directional exposure.

The futures premium varies with market sentiment. In bullish markets, futures command a higher premium (6-9%), generating better returns. In bearish or range-bound markets, the premium compresses (5-6%). This is why arbitrage fund returns are not fixed - they track the market's willingness to pay a futures premium, not the RBI repo rate.

The convergence mechanism is key: as the arbitrage trade is executed, the price difference between spot and futures narrows to zero by futures expiry (typically last Thursday of the month). The fund manager closes both positions at expiry, capturing the spread as profit regardless of whether the stock price went up or down. The return therefore comes from the market's willingness to pay a futures premium , which varies with market sentiment. In bullish markets with high retail F&O participation (as in 2024-2025 India), futures command a premium of 7-9% annualized, producing strong arbitrage returns. In range-bound or bearish markets, the premium compresses to 5-6%. Budget 2026's STT hike on futures (effective April 1, 2026) directly reduces the net spread captured per trade by approximately 25-30 bps annually , because the fund pays 0.05% STT on each futures transaction (up from 0.02%). The fund cannot avoid this cost by switching to options , the STT on options premium also rose to 0.15%. The remaining spread post-STT hike is approximately 6.5-7% annualized (from 7-7.5% pre-hike), still substantially above FD post-tax returns at the 30% bracket. NAV moves daily as positions are marked to market , you will see small fluctuations in arbitrage fund NAV, unlike an FD where the balance never drops. These fluctuations are accounting adjustments from open futures positions, not real losses , closed positions always settle at the locked-in spread.

3. The Core Tax Comparison

The core tax structure: FD interest is added to total income and taxed at your slab rate every year , there is no deferral, no exemption, no LTCG benefit. A 7% FD at 30% slab leaves 4.9% post-tax. Arbitrage fund held beyond 12 months: gains are LTCG taxed at 12.5% only on gains above ₹1.25L aggregate (across all equity holdings). At 7% return, ₹10L in arbitrage generates ₹70,000 annual gain , entirely within the ₹1.25L exemption , effectively 0% tax. This creates a post-tax gap of approximately 2.1% per year at the 30% slab, entirely from tax treatment, not from any return difference. Post-Budget 2026 STT hike (futures STT from 0.02% to 0.05%) narrows this by 25-30 bps , but Edelweiss MF estimates the post-tax edge over liquid funds remains at approximately 90 bps even after the hike. Use the Mutual Fund Tax Calculator to compute the exact post-tax return on your specific arbitrage fund holding amount and period.

4. Post-Tax Returns Across All 3 Tax Slabs

Assuming identical 7% pre-tax returns for both instruments. This table proves why short-term Arbitrage holding is actually worse for lower-income brackets.

*Assumes STCG is absorbed by basic exemption limit. **LTCG is fully 7.0% if total equity gains stay under the ₹1.25L annual exemption. If gains exceed ₹1.25L, the marginal post-tax return above the limit is 6.09% (13% tax including cess on the marginal gain). FD includes 4% cess.

The slab-rate dependency is the most important nuance in arbitrage fund analysis. At 0% slab: both FD and arbitrage fund are effectively tax-free (no tax on either). Arbitrage fund has no advantage. At 5% slab: STCG on arbitrage fund is 20% flat , higher than the 5% FD tax rate. For holding periods under 12 months, FD wins at the 5% bracket. After 12 months (LTCG): arbitrage fund wins back via lower 12.5% vs 5% slab (approximately equal), or 0% if under ₹1.25L threshold. At 10% slab: same STCG trap applies , arbitrage STCG at 20% is double the FD slab tax of 10%. LTCG advantage kicks in meaningfully after 12 months. At 20% slab: STCG at 20% equals the FD slab tax exactly , no advantage or disadvantage under 12 months. LTCG advantage begins: 12.5% vs 20.8% (20% slab + 4% cess) = meaningful gap. At 30% slab: the full advantage is visible at all time horizons beyond 12 months. STCG still worse (20.8% vs 31.2%), but LTCG at 12.5% vs 31.2% is the largest gap. The critical insight: arbitrage fund's tax advantage is entirely a function of holding period and tax bracket. Under 12 months at any slab below 20%, FD is better. Over 12 months at any slab above 20%, arbitrage fund wins by a significant margin. The Income Tax Calculator helps you identify your effective slab rate including surcharge and cess.

5. Corpus Comparison: ₹1L to ₹25L for 1 Year (30% Bracket)

Let's map out the actual cash difference for a high-income earner parking funds for a little over a year to claim LTCG benefits.

*Calculations at 7% pre-tax return. FD includes 31.2% tax. Arbitrage STCG at 20.8%. Arbitrage LTCG calculated applying the ₹1.25L exemption, with remaining gain taxed at 13%. Up to ₹17.8L invested at 7% will generate gains entirely within the ₹1.25L tax-free threshold.

The ₹1L-₹25L corpus range captures most individual parking scenarios. For ₹1L corpus at 7% return: annual gain = ₹7,000 , fully within ₹1.25L LTCG exemption after 12 months, effectively 0% tax. FD equivalent: ₹7,000 gain at 30% slab = ₹2,184 tax. Tax saved = ₹2,184 per year. For ₹10L corpus at 7% return: annual gain = ₹70,000 , still within ₹1.25L exemption assuming no other equity LTCG. Effectively 0% tax. FD tax = ₹21,840. Tax saved = ₹21,840 per year. For ₹18L corpus at 7% return: annual gain = ₹1,26,000 , just above ₹1.25L threshold. Tax on marginal ₹1,000 gain = ₹125 at 12.5%. FD tax = ₹39,312. Tax saved per year = ₹39,187. For ₹25L corpus at 7% return: annual gain = ₹1,75,000. Arbitrage LTCG tax = 12.5% on ₹50,000 = ₹6,250. FD tax = ₹54,600. Tax saved = ₹48,350 per year. For investors at 30% slab with ₹10-25L to park for 12-18 months, arbitrage fund's post-tax advantage is ₹21,000-₹48,000 per year compared to FD , entirely from tax efficiency, not from different investment risk. The Lumpsum Calculator models post-tax corpus growth across different return rates and time periods.

6. Exit Load and Holding Period Rules

This is where most investors trip up. Arbitrage funds are not as liquid as savings accounts or liquid funds for very short holding periods.

Exit load is the primary operational constraint of arbitrage funds. Most levy 0.25% if redeemed within 30 days. This is not a tax , it is a fund cost that goes back into the scheme's NAV for remaining investors. The practical implication: arbitrage funds are not suitable for money you may need within the next 30 days. For 31-day to 12-month holding, no exit load applies but STCG applies (20% + cess). For 12+ months: no exit load, LTCG treatment , the sweet spot for tax efficiency. The 30-day lock creates a practical minimum holding period. This disqualifies arbitrage funds from replacing current accounts, savings accounts, or very-short-duration liquid parking (under 30 days). However, for amounts you can commit for 31+ days , bonus received in January, to be used for EMI in March , arbitrage beats liquid fund on post-tax return because liquid fund gains are now taxed at slab rate (post-April 2023). The exit load rule also creates an unexpected planning opportunity: if you invest on November 1 and redeem on December 2 (31 days), exit load is zero and STCG applies. If held until November 1 of the following year (12 months), LTCG applies with ₹1.25L exemption. Timing the redemption around the 12-month mark is the most common and effective tax planning strategy for arbitrage fund investors. The Mutual Fund Tax Calculator computes exact STCG vs LTCG for your specific investment date and redemption date.

7. Arbitrage Fund vs Liquid Fund vs Short-Duration Debt Fund

All three instruments occupy the low-risk, short-term segment. Here's how they compare across the factors that matter.

*Debt funds purchased on or after 1 April 2023 - taxed at slab rate under Section 50AA regardless of holding period. See our full SIP LTCG tax guide for context on how debt fund taxation changed post-2023.

The post-April-2023 debt fund tax change eliminated the tax advantage that debt funds previously held over FDs. Arbitrage funds are now the only instrument in the low-risk, short-term segment that offers a materially lower tax rate for 20-30% bracket investors.

The three-way comparison sharpens the decision framework significantly. Liquid fund vs arbitrage fund: both invest in similar instruments (liquid fund = short-duration debt, arbitrage fund = hedged equity + debt margin). Tax treatment is the key difference: liquid fund gains taxed at slab rate (31.2% at 30% slab); arbitrage LTCG at 12.5% after 12 months. Post-Budget 2026 STT hike narrows the gap but arbitrage still leads by approximately 90 bps post-tax on a comparable basis (Edelweiss MF estimate). Short-duration debt fund vs arbitrage fund: short-duration funds offer predictable interest income but are taxed at slab rate (post-April 2023 rule). At 30% slab, a 7.5% short-duration fund nets approximately 5.22% post-tax. Arbitrage LTCG nets 6.09-7% post-tax depending on annual gain level. Short-duration funds win on predictability and duration flexibility , no 30-day lock-in, no equity volatility in daily NAV. Arbitrage wins on post-tax return. Recommendation: for amounts committed for 12+ months where tax efficiency is priority, arbitrage wins. For amounts needing maximum flexibility with potentially shorter or uncertain redemption timeline, short-duration debt fund is better. The RD vs FD vs SIP comparison covers the broader debt instrument decision tree including post-tax returns across all categories. The expense ratio guide explains how fund costs reduce the pre-tax return before the tax advantage even applies.

8. LTCG Harvest Strategy for Arbitrage Funds

Since arbitrage funds qualify for equity LTCG treatment, the annual ₹1.25L harvest strategy applies here too. For medium-term parking of ₹15-25 lakh, systematic annual harvesting can reduce the effective tax rate to absolutely zero.

The LTCG harvest strategy leverages the ₹1.25L annual exemption as a recurring tax-free income window. Mechanics: invest ₹18L (approximate) in arbitrage fund in April. By March (12 months later), redeem to book up to ₹1.25L LTCG tax-free. Immediately reinvest the redeemed amount at the new NAV , resetting the cost basis. Next year, repeat. The effective tax rate on a perpetual ₹18L arbitrage fund position maintained this way: 0% on LTCG, indefinitely, as long as gains stay under ₹1.25L per year. At 7% return on ₹18L: ₹1.26L gain , just barely over the threshold. The marginal tax on the excess ₹1,000 is ₹125. Effective tax rate: 0.07%. Important: the ₹1.25L exemption is aggregate across all equity instruments , stocks, equity MFs, and arbitrage funds combined. If you have ₹80,000 LTCG from equity funds, only ₹45,000 remains of the arbitrage fund exemption. Track the aggregate carefully. The harvest must happen before March 31 (fiscal year end) to count for that year's exemption. Use the Capital Gains Calculator to track your remaining annual LTCG headroom before initiating the harvest redemption. The Mutual Fund Tax Calculator shows the exact tax if you overshoot the ₹1.25L threshold.

9. Popular Arbitrage Funds in India

These are among the largest and most established arbitrage funds in India by AUM, included here for reference. Past performance is not indicative of future returns.

The arbitrage fund category is well-established with multiple fund houses offering comparable strategies. Kotak Equity Arbitrage Fund (KEAF): largest AUM in the category; delivered ~7.50% post-expense return in FY25; STCG + cess ~23.92%. Nippon India Arbitrage Fund, HDFC Arbitrage Fund, and SBI Arbitrage Opportunities Fund are other large AUM options with similar strategy profiles. Performance across funds in the arbitrage category tends to converge , because the strategy (cash-futures spread capture) is the same. The spread available in the market determines all funds' returns. Fund selection criteria for arbitrage funds: expense ratio (lower is better, since all funds chase the same spread), AUM (larger AUM funds have better execution and lower market impact), and liquidity of redemption processing. Arbitrage fund AUM category-wide saw ₹4,192 crore net inflows in November 2025 alone , reflecting growing investor awareness of the post-tax advantage. The expense ratio guide explains why even 0.1% difference in expense ratio compounds significantly over 3-5 years of parking. For the actual tax computation on any arbitrage fund holding, use the Mutual Fund Tax Calculator which handles per-instalment LTCG/STCG calculations.

10. Who Should Choose What

11. The Budget 2026 STT Hike , What It Means for Arbitrage Fund Returns

Budget 2026 raised STT on futures contracts from 0.02% to 0.05% (effective April 1, 2026), with options premium STT rising to 0.15%. The stated goal was to reduce speculative F&O trading. The collateral impact on arbitrage funds is structural: because arbitrage funds rely heavily on the futures market to hedge their cash market positions, higher STT is a direct cost on every transaction. Edelweiss MF estimates the annual drag at 25-30 basis points , reducing a 7.5% pre-hike return to approximately 7.2-7.25% post-hike. This is real but not fatal. The post-tax edge over liquid funds narrows from approximately 120-150 bps to approximately 90 bps. The advantage has not disappeared , it has compressed. For investors comparing arbitrage funds to FDs at the 30% slab, the post-hike comparison remains strongly in favour of arbitrage funds held beyond 12 months: 7.2% × (1 - 12.5%) = 6.3% post-tax vs FD 7% × (1 - 31.2%) = 4.82% post-tax , a gap of 148 bps, even post-STT hike. The STT hike is a reason to update return expectations, not a reason to exit the category. Use the Mutual Fund Tax Calculator with revised 7.2% pre-tax return (post-Budget 2026) for the most accurate post-tax comparison.

12. The Section 87A Trap , The Costly Mistake Arbitrage Fund Investors Make

Section 87A provides a tax rebate (currently ₹60,000 effective for incomes up to ₹12L under new regime) that effectively makes income tax zero for many salaried taxpayers. A critical and common error: assuming this rebate offsets the capital gains tax on arbitrage fund redemptions. It does not. Special-rate income , STCG under Section 111A and LTCG under Section 112A , does not qualify for Section 87A rebate, regardless of total income level. Practical scenario: a salaried employee with ₹11L annual salary (new regime, qualifies for full 87A rebate, effectively pays zero income tax on salary). They also redeem arbitrage fund units with ₹80,000 STCG (held under 12 months). Expected by many: 87A rebate covers the STCG too. Actual tax: STCG at 20% = ₹16,000 + 4% cess = ₹16,640 , this must be paid regardless of 87A rebate status. The LTCG exemption (₹1.25L) is separate from 87A and does apply , so LTCG up to ₹1.25L is genuinely tax-free. But 87A provides no additional protection for equity capital gains beyond the ₹1.25L LTCG threshold. Investors who plan their arbitrage fund redemptions expecting 87A to cover the tax will face surprise tax demands and potential interest charges for underpayment of advance tax. Plan redemptions using the Income Tax Calculator with capital gains included , do not assume 87A covers gains.

13. Arbitrage Fund as Emergency Fund , Why It Works and Where It Fails

Arbitrage funds are increasingly being positioned as an alternative to keeping emergency funds in savings accounts or liquid funds. The case for arbitrage fund emergency allocation: post-tax returns significantly exceed savings account interest (2.5-3.5%) at all slab rates. Daily NAV (withdrawals processed within 1-2 business days). No lock-in beyond 30 days. The case against: a true emergency , job loss, medical event , may require funds within 30 days. Arbitrage fund exit load of 0.25% in the first 30 days erodes returns and reduces the effective amount available. For a ₹5L emergency fund in arbitrage fund: if you need it on Day 15, exit load = ₹1,250 , small but present. FD or savings account has no exit cost. The recommended structure: Tier 1 emergency fund (1-2 months expenses) , savings account or liquid fund. Zero exit friction, T+1 liquidity. Tier 2 emergency fund (4 months expenses) , arbitrage fund. Held for 31+ days before any potential need, capturing post-tax advantage. This split maximises post-tax return on the emergency corpus (approximately 70-75% earns the higher arbitrage return) while maintaining zero-friction liquidity for immediate needs. The Emergency Fund Calculator calculates how much to keep by tier. The emergency fund guide covers the full tiered structure with specific instrument recommendations.

One more consideration for emergency fund allocation in arbitrage: the STCG trap at lower brackets. A 5% or 10% slab investor who parks emergency funds in arbitrage and needs to redeem within 12 months faces STCG at 20% , higher than their own FD tax rate. For these investors, liquid fund (slab rate tax matching their lower bracket) is better than arbitrage fund for the emergency allocation. The arbitrage fund emergency allocation is specifically optimal for 20%+ slab investors committing to a 31-day+ minimum hold before potential redemption. Use the Emergency Fund Calculator to size both tiers, and the Mutual Fund Tax Calculator to verify post-tax returns at your specific slab before allocating.

14. The Three-Layer Short-Duration Portfolio , Where Arbitrage Fits

Most Indian investors treat all short-duration money identically , savings account, FD, or liquid fund. A three-layer structure optimises the entire short-duration allocation for post-tax returns without sacrificing liquidity where it is needed most. Layer 1 , Liquid (0-30 days, 10-15% of short-duration allocation): savings account or liquid fund. T+1 redemption, no exit friction, slab-rate taxation accepted for the small amount. Layer 2 , Tactical (31 days to 12 months, 40-50%): arbitrage fund. No exit load after 30 days. STCG applies but still better than FD at 20%+ slab. Best suited for bonus, quarterly surplus, money needed in 3-6 months. Layer 3 , Strategic (12+ months, 40-50%): arbitrage fund (LTCG treatment) or SCSS/PPF for guaranteed instruments. At 12+ months, LTCG gives the maximum post-tax advantage. For senior citizens specifically, SCSS at 8.2% offers guaranteed return with Section 80TTB deduction (₹50K), making it competitive with arbitrage fund LTCG for that specific segment. The SCSS Calculator models senior citizen savings scheme returns. The SWP vs FD guide covers how to combine these instruments for monthly income generation. For the full post-tax comparison across all short-duration instruments at your specific tax bracket, use the Mutual Fund Tax Calculator alongside the Real Return Calculator for inflation adjustment.

The three-layer approach requires an annual review , as corpus grows, arbitrage fund gains may cross the ₹1.25L LTCG threshold, shifting the optimal allocation between layers. Review every April using the Capital Gains Calculator to check remaining LTCG headroom before the next financial year begins.

The verdict by investor profile, incorporating all 2026 considerations including the STT hike: High-bracket (30% slab) investor parking ₹5L+ for 12+ months: arbitrage fund is the clear default over FD and liquid fund. Post-tax return advantage of 100-150 bps post-STT hike is significant and consistent. Mid-bracket (20% slab) investor, 12+ month horizon: arbitrage LTCG at 12.5% vs FD at 20.8% , still 86 bps advantage per year. Worth the switch especially for amounts generating under ₹1.25L annual LTCG (effectively tax-free). Low-bracket (10% slab or below), any duration: FD wins under 12 months (STCG at 20% is worse than 10% FD slab). Arbitrage only viable for 12+ month commitments where LTCG applies. Investors needing money within 30 days: never arbitrage fund. Savings account or liquid fund for Tier 1 emergency needs. Senior citizens: evaluate SCSS at 8.2% (Section 80TTB deduction of ₹50K) vs arbitrage fund LTCG. SCSS may win for smaller amounts where 80TTB covers most interest income. New regime taxpayers with no 80C deductions: arbitrage fund advantage is even clearer , no alternative tax-saving mechanism from FD, making the post-tax gap all the more important. The bottom line: arbitrage fund is not a replacement for FDs universally , it is the superior choice specifically for the 30% bracket investor who can commit for 12+ months and who has no compelling reason to use the FD's DICGC insurance guarantee. Use the Mutual Fund Tax Calculator and the Real Return Calculator to compute your specific outcome before switching.