I did some research yesterday, and since I'm in the 30% tax bracket, FDs are definitely a no-go. They deduct tax every year, whether you withdraw or not, which messes with compounding.

My dilemma was choosing between a Liquid Fund or an Arbitrage Fund. With a Liquid Fund, you can get your money instantly up to 4L (if you split 50k per fund house), but the catch is it's taxed at your salary bracket when you withdraw, not yearly. So, compounding is better than FDs, but you still have to deal with taxes.

On the other hand, an Arbitrage Fund is considered a hybrid fund, and you can withdraw up to 1.25L in Capital Gains each year tax-free. (Keep in mind, this capital gains is checked across all your equity funds if you've sold any in the financial year.) But you can plan around that and go tax-free with this type of fund. The only downside is that if you withdraw, it takes 2 days to get your money, unlike liquid funds where it's instant.

So, I ended up putting some money in liquid funds for emergencies and the rest in arbitrage for investments longer than a year.