For shorter durations, few days to few months; Overnight funds / Liquid funds / Money Market funds are alright. High Yield Savings Account (HYSA) are ok. If large amount, consider registered advisor.
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First of all, it should be clear what you mean when you say "park money". You intend to keep some money safe somewhere for a requirement that's going to come up in the near future (somewhere between a few days to 1-3 years down the line).
Let's start with the absolute basic thing you can do. Nothing. If you want to park money for a few days or a few months, you can keep it in your savings bank account which, as of Jan 2021, would yield anywhere from to in too big to fail banks like SBI, HDFC, and ICICI. Axis Bank and Kotak Mahindra Bank are offering upto .
You can also park your money in a high yield savings account, if available. Banks may offer abnormally high interest rates for many reasons. For example, IDFC First Bank was offering upto interest rate (archive.org link | archive.is link) during Jan 2021. This was at a time when big banks like SBI were offering on their saving account. In this case, IDFC First Bank wanted to improve its Current Account Savings Account (CASA) ratio. As their CASA ratio improved, they decreased their interest rates accordingly. For more details, check out page 42 of the Q3 FY21 investor presentation (archive.org link) from IDFC First Bank.
As a thumb rule, avoid co-operative banks and small finance banks. Although DICGC insures your deposits in a bank account up to ₹5 lakh, it's better not to rely on it and take unnecessary risks.
Check out the links mentioned below if you want to know how to evaluate the health and safety of banks in India.
You can get a deduction of on earnings generated from interest in savings bank accounts under Section 80TTA. Senior citizens get a deduction of under Section 80TTB and this includes interest earned from savings bank accounts as well as bank fixed deposits.
The second natural choice for most people should be bank fixed deposits which have reasonable liquidity and safety for parking money. As of January 2021, most big banks are offering anywhere between to interest rates on FDs. However, unlike bank accounts which are tax-exempt if the interest amount is less than , all interest income from a fixed deposit is taxable. The bank will auto deduct TDS @ if your interest income from FDs exceed . You’ll have to pay any additional taxes later if you fall under income tax slabs higher than .
You can also park your money in certain debt mutual funds. This includes overnight funds and liquid funds for parking money for a few months and money market funds for a few years. However, note that unlike savings account and fixed deposits, debt mutual funds are marked to market which means that you should expect some volatility in day to day NAV. This volatility is mostly negligible in overnight and liquid funds, but we have seen events like the Covid-19 crash in March 2020, when even liquid funds experienced a few days of relatively high volatility.
Here are the NAV graphs of HDFC Liquid fund, the biggest liquid fund in India in terms of AUM, and Parag Parikh Liquid fund, during the covid crisis.
Prior to the 2023 Budget, debt funds used to enjoy indexation benefits when it comes to taxation if they were held for 3 years or more. This is no longer the case for debt fund investments made on or after 1st April, 2023.
The below example showcases indexation benefits applicable if you had invested in a debt fund prior to 31st March, 2023.
We've considered the Cost of Inflation Index (CII) values between FY19 and FY21, which are 280 and 301, respectively. The indexed cost of investment, at the time of redemption in FY21, becomes
Last, but not least, there are arbitrage funds. These debt MFs are taxed like equity MFs so you don’t have to pay any taxes if you park your money for more than a year and your gains during redemption don’t exceed ₹1 lakh. This might sound good on paper but arbitrage funds are significantly more volatile than liquid funds and don’t offer instant redemptions either. The returns from arbitrage funds also depend on the availability of arbitrage opportunities and this has started to come into question. For more details, check out this article (archive.org link | archive.is link).
At the end of the day, when it comes to parking money in arbitrage funds, buyer beware.
Now that we've covered where you can park your money, we'll list some instruments where you probably shouldn't park money for planned redemption in the near future.
any debt mutual fund with somewhat significant interest rate or credit risk This includes credit risk funds, dynamic bond funds, gilt funds, banking & PSU funds, ultra short, short, low, medium, and long duration funds, and corporate debt funds.
hybrid mutual funds
index funds like UTI Nifty index fund
any other sort of equity mutual fund
stocks
That being said, investments in debt funds don’t incur TDS or taxes until you redeem money from them. Many liquid funds also offer instant redemption up to at any time of the day although the reliability of the instant redemption depends on the AMC website.
As an example, let's consider lakh parked for 1 year in a bank account, a fixed deposit, and a liquid fund. The interest earned and the actual interest earned after taxes, assuming tax slab, are mentioned as follows:
Since the interest earned from Savings Account is less than , this is tax free income. FD and Debt Mutual Funds are taxed at the applicable tax slab.
Let's see what happens when we park lakh for 3 years. This is where indexation benefits come into the picture in debt mutual funds.
The indexed gains are and this is taxed at . The taxes payable are . This gives us our actual realized gains of .
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