Everybody keeps their money in a bank account.
And the bank account gives you an interest for the money kept.
This is usually 3.5% p.a.
Savings account, as the name suggests, is not an investment account.
It ensures that the depositor’s money is liquid i.e. available at his/ her disposal at any point of time whenever required by the depositor.
In this process, a depositor earns a nominal interest on short-term deposit or no interest at all, as the case may be.
Most of us would do this, but the question that needs to be asked and addressed is: Is this the best utilization of the excess funds available at the disposal of the investor?
This is where liquid funds come into the picture.
It can be considered as an option for an even better utilization of your idle funds.
In this article
Comparison of liquid funds and savings bank account
|Savings Bank Account||Liquid Funds|
|Very low-risk||Risk similar to savings bank but slightly higher|
|Returns: 3.5-5% p.a.||Returns: 6.5-7% p.a.|
|Tax: as per income slab||Tax: Very low due to indexation (long term)|
Your hard-earned money parked at any savings bank account yields a very low rate of interest to you.
This interest is generally to the tune of 3.5%-4%. There are some banks which offer a high-interest rate of up to 6%. But these banks usually have a high minimum balance that you have to maintain.
In comparison to the above, liquid fund schemes offer higher returns – 6.5%-7% p.a.
This comes without any strings attached in the form of minimum balance requirement or minimum investment duration.
Therefore, liquid funds provide higher returns as compared to liquid funds for a short investment duration.
Liquid funds carry a very low risk. So low in fact that the risk can be compared to that of a savings bank account.
However, it is important to understand that investment in any mutual fund in general and liquid fund, in particular, entails market risk.
Depending on the market circumstances, the Net Asset Value (or NAV) changes.
Savings bank account generally entails no investment risk at all. Therefore, it subsequently affects the interest, which is always low.
3. Tax outgo
Liquid funds entail a lower tax expense owing to the benefit of indexation.
Long-term capital gains on liquid fund schemes which are held for a period of more than 3 years are taxed at 20% after allowing the benefit of indexation.
Indexation of costs allows for a lower income, for the purpose of earning calculation owing to the increased cost allowance.
Therefore, in the case of an investment in liquid funds, the effective tax rate is reduced due to the benefit of indexation. This makes a huge difference in the net tax outgo of the investor.
However, in a savings bank account, the tax is not eligible for the benefit of indexation. Interest income from savings bank account is exempt up to ₹10,000.
Why liquid funds?
Liquid funds help investors earn a higher rate of interest as compared to savings bank investment, that too with a considerably low risk.
Liquid funds are simply debt mutual funds wherein the investor’s money is invested in short-term market instruments such as treasury bills, government securities among others that hold the least amount of risk.
These funds invest in instruments that have a maturity of up to 91 days.
The point to note here is that liquid funds allow investors to invest their money for a very short period of time, even a couple of days or months, and earn a return on the period of their investment.
It is therefore highly liquid and good return provider for a short-term investment.
Disadvantage of liquid funds
There is one major disadvantage of keeping money in a liquid fund that can affect you. The money in a liquid fund is not immediately available to you.
It takes 1-2 working days to withdraw money from a liquid fund. This means you do not have access to it on holidays.
Upon a thorough analysis of the above-mentioned parameters, it is safe to say that liquid funds have their advantages over depositing idle money in a savings bank account.
As far as the returns are concerned, liquid funds deliver nearly double returns as compared to a traditional deposit in the savings account of most banks.
The risk of investing in liquid funds is higher only by a small margin, as compared to depositing money in the savings bank account.
Disclaimer: the views expressed here are of the author and do not reflect those of Groww.