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.

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)

1. Returns

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.

2. Risk

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 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.

The 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.

Savings Bank Interest Rates

BANK INTEREST RATE
Yes Bank Savings Value Account Interest Rate 5.00% – 6.25%
Kotak Bank Nova Savings Account Interest Rate 5.00%-6.00%
Standard Chartered Basic Banking Account Interest Rate 4.00%
Canara Bank Savings Bank Account Interest Rate 4.00%
Citibank Savings Accounts Interest Rate 4.00%
UCO Bank Saral Savings Deposit Scheme Interest Rate 4.00%
IDFC Bank Savings Account Interest Rate 4.00%
Andhra Bank Abhaya SB Account Interest Rate 4.00%
South Indian Bank Regular Savings Interest Rate 4.00%
IDBI Bank Super Savings Account Interest Rate 4.00%
SBI Bank Savings Bank Account Interest Rate 3.50%-4.00%
Indian Bank Savings Bank Account Interest Rate 3.50%-4.00%
HDFC Bank Regular Savings Account Interest Rate 3.50%-4.00%
PNB General Savings Account Interest Rate 3.50%-4.00%
ICICI Bank  Regular Savings Account Interest Rate 3.50%-4.00%
Bank of Baroda Savings Account Interest Rate 3.50%-4.00%
Axis Bank Basic Savings Account Interest Rate 3.50%-4.00%

The table shows the interest rate by the top banks.

Most of the banks in India offer 4% interest rate per annum on the savings deposit even though the Reserve Bank of India has deregulated the interest rate on savings bank.

Those banks which offer a little higher rate demand a high minimum balance amount in the account.

Therefore the surplus amount parked in savings accounts yields a very low-interest-rate earning which might not be enough even to cover the inflation.

But liquid funds offer higher rates without compromising on the amount and time of investment.

What are Liquid Funds?

Liquid fund meaning: liquid funds are a type of mutual fund with incredibly low-risk associated with them. The returns given by them are slightly higher than what you would get in a savings bank account.

They are also very liquid – which means it takes very little time to invest and take out money from liquid funds.

While other mutual funds can take anywhere between 3-4 working days to invest and redeem money, liquid funds take around 1-2 working days.

Liquid funds are mutual funds where the investments are majorly done in very short-term or money market instruments such as treasury bills, certificate of deposits, term deposits and commercial paper.

With the bank interest rates going down, many investors use the liquid funds to park their money for a short period of time.

Returns from Liquid Fund

Like all other mutual funds, liquid funds also invest in securities that have a market price and Net Asset Value (NAV) which moves accordingly with the movement of the market price.

But the movement in the NAV of the liquid fund is not like other mutual funds because the interest earned by the funds through the tenure of the security is divided equally for the number of days the security is held making fund’s NAV movement more or less linear (like a steady line going up).

During the period of high inflation, the Reserve Bank keeps interest rates high and tightens the liquidity thus making the liquid funds one of the best investment options.

Tax on Liquid Funds

Liquid funds taxation: For gains made before a year from investment, investors are taxed as per the income slab similar to the tax on interest earned on savings bank account.

For long-term capital gains i.e. if the funds are redeemed after 3 years, it is taxed at 11.33% (including surcharge and cess) or 22.66% with the benefit of indexation, whichever is lower.

Conclusion

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.

Happy Investing!

Disclaimer: the views expressed here are of the author and do not reflect those of Groww.