In India, fixed deposits are the oldest and are probably the most-trusted forms of investing. Before shares and mutual funds started gaining attention as good investment avenues, fixed deposits were the go-to name for parking saved funds and earning interest. There were many benefits offered by fixed deposits including low risks, reasonable returns, and high liquidity. Over the years, as investors started exploring mutual funds, various debt and equity funds were launched to suit the requirements of different kinds of investors. Of these, liquid funds have a similar risk profile as an FD and hence, most investors compare them with fixed deposits to choose between the two. Today, we will offer a comparative analysis of FDs and Liquid Funds to help you make the decision.
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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 managed to accumulate the required funds in January. Since you won’t need the funds until December, keeping them in a savings account would attract low interest. These funds can be invested until December in instruments that generate higher returns than a savings account but do not compromise on the safety of the principal amount.
The first option that comes to mind in such scenarios 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 can consider for such short-term investments is a liquid mutual fund. This is a type of debt fund that invests in fixed-income instruments like commercial paper, government securities, treasury bills, etc. with a maturity of up to 91 days. It focuses primarily on offering capital protection and liquidity to investors and 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.1 lakh per bank.||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 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 Securities and Exchange Board of India (SEBI) announced exit loads for liquid funds redeemed within seven days of holding them. This is a graded structure. Holding a liquid fund for one day and exiting it will attract an exit load of 0.007%, holding for two days – 0.0065%, three days – 0.006%, four days – 0.0055%, five days – 0.005%, and six days – 0.0045%. 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 fixed deposits.|
|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? Here are some tips:
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 while fixed deposits offered by banks are regulated by the RBI, if you are planning on investing in one from an NBFC, then you will have to check its CRISIL ratings before investing. It is 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 must consider investing in liquid funds if you have a low-medium tolerance for risk and desire higher returns than those offered by fixed deposits. While these funds don’t assure any returns, they tend to offer better returns than FDs.
As you can see, while fixed deposits and liquid funds are great options for low-risk investments, they have unique features that make them ideal for different types of investors. Hence, before you choose between the two, understand your financial goals, investment horizon, and risk tolerance. These aspects will help you choose the right option at any time during your investment journey.
Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. NBT do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.