Liquid Funds vs FD: A Comparative Analysis
In India, fixed deposits are the oldest and probably the most trusted form of investing.
Before shares and mutual funds started gaining attention, fixed deposits were the go-to name for investment and steady returns. There were many benefits offered by fixed deposits including low risks, reasonable returns, and high liquidity.
Over the years, different types of funds were launched to suit the requirements of different kinds of investors. Particularly for those who prefer FDs.
Among the funds, liquid funds have a similar risk profile as an FD and hence, most investors compare them with fixed deposits.
Here is what you should know before you make an investment in either of the instruments.
Fixed Deposits and Liquid Funds
There are times when you have funds lying idle for a short period. Let’s say that you want to go on an international vacation in December and have accumulated funds in January. And keeping them in a savings account would attract low interest.
The first option is a fixed deposit. This is an investment instrument that offers a fixed interest rate for a specific tenure. It is offered by banks and non-banking financial companies (NBFCs). The interest rate is higher than that offered by a savings account.
Another option that you, as an investor, can consider for such short-term is a liquid mutual fund. This is a type of debt fund that invests in fixed-income instruments such as commercial paper, government securities, and treasury bills. It focuses primarily on offering capital protection and liquidity to investors. The fund manager endeavors to generate returns better than savings account interest.
Comparison Between Fixed Deposits and Liquid Funds
Here are some comparison points between fixed deposits and liquid funds:
| Feature | Fixed Deposits | Liquid Mutual Funds |
| Risk | These are considered to be extremely-low risk investments since they are offered by banks or NBFCs and usually have an insurance policy protecting the invested capital and interest up to Rs.5 lakh per bank account. | Liquid mutual funds invest in fixed-income instruments. These instruments are affected by the market volatility and overall state of the economy. Hence, these funds carry a relatively higher risk as compared to fixed deposits. |
| Returns | Fixed deposits offer a fixed rate of return that is governed by the Reserve Bank of India based on the condition of the economy and the financial system in the country. While the returns are higher than savings accounts, they are lower than liquid funds. | Liquid mutual funds do not offer any guaranteed returns. However, they tend to offer better returns than fixed deposits. It is important to ensure that the fund manager does not take high risks while managing the fund’s portfolio. You need to read the offer document carefully before investing. |
| Liquidity | Fixed deposits have a maturity date and the rate of interest is offered based on the principal amount and tenure of the deposit. While you can prematurely withdraw your funds, a penalty is levied for the same (usually around one percent of the applicable interest). Hence, while fixed deposits offer liquidity, it comes at a price. | While you could redeem liquid fund units at any time without any exit loads, last year, the SEBI announced exit loads for liquid funds redeemed within seven days of holding them. This is a graded structure. For instance, holding a liquid fund for one day and exiting it will attract an exit load of 0.007%, and holding for two days – 0.0065%. From the seventh day onwards, there is no exit load on redemptions. Hence, liquid funds offer better liquidity at lower penalty charges as compared to FDs. |
| Investment Horizon | You can invest in a fixed deposit for a tenure ranging from seven days to ten years. | Liquid funds have a maturity of up to 91 days. |
| Taxation | The interest earned from fixed deposits is added to your annual income and taxed as per the applicable tax slab. Also, whenever interest is paid out or accrued, the bank/NBFC deducts 10% TDS. At the end of the year, you need to deduct the TDS amount from your overall tax liability and pay the difference. You can also invest in a tax-saving fixed deposit with a lock-in of three years to claim tax deductions of up to Rs.1.5 lakh under Section 80C of the Income Tax Act, 1961. | If you hold liquid fund investments for more than three years, your returns will be considered as long-term capital gains and taxed at 20% after indexation. On the other hand, for investments held for three years or less, the returns are taxed per your applicable income tax slab. |
How to Choose between the two?
As you can see, both fixed deposits and liquid funds have certain pros and cons. So, how do you choose between the two?
Who should consider investing in a fixed deposit?
Fixed deposits are ideal for investors with extremely low to zero risk tolerance. However, it is important to remember that if you are planning on investing in one from an NBFC, then you will have to check its ratings given by agencies such as CRISIL before investing. Though FDs with banks are much safer than NBFCs.
FDs are generally a good long-term investment option for investors looking for returns better than savings accounts and with a low tolerance for risk.
Who should consider investing in liquid funds?
Liquid funds invest in fixed-income instruments and endeavor to offer capital protection and liquidity to investors. Hence, they invest in high-quality instruments only. This makes them safer than other mutual funds. However, they are riskier than fixed deposits.
Hence, you can consider investing in liquid funds if you have a low-medium tolerance for risk. While these funds don’t assure any returns, they tend to offer better returns than FDs.
Happy Investing!