Are Liquid Funds Better Than Savings Account?

Are Liquid Funds are better than a savings account?

Well, if you are looking for more interest then “Yes” but if you’re looking for a 100% risk-free option then “No”. Both the accounts have their pros and cons and I will walk you through the all advantages and disadvantages of both i.e. Liquid Funds and Savings account.

Are Liquid Funds Better Than Savings Account?

Savings account in the banks is the best place to park our money safely and earn reasonable interest at the same time. Savings account provides greater flexibility of depositing or withdrawing money whenever it’s required.

Returns on the liquid mutual funds are applied to the income tax. Short term capital gains are added to your income and taxed as per the income tax slab. Long term capital gains gets the benefit of indexation and 20% flat tax applicable. Check out my previous post on debt fund taxation for a detailed explanation.

However, keeping money in a savings account that you are not seeing any use soon doesn’t make sense because interest which you get in a savings account is very less. It doesn’t mean, you should have a savings account;

You Need A Savings Account Because

  • Your money is 100% safe and risk-free in a savings account
  • Withdrawal is possible whenever it is required.
  • You get interest even though it is less.
  • You have instant access to your fund in an emergency or difficult times.
  • You can park your fund which you might need near future.
  • You can manage your utility/bill payment, rent payment, education fees, and other expenses very efficiently with a savings account.
  • You can park your student inflow fund safely when you’re unsure of where to invest and utilize it as and when any good opportunity arises.

But, on the other hand, the interest rates in the savings account have come down drastically and it hardly offers a 4% interest rate. This makes investors look for an alternative to a savings account that could offer the same benefits as savings account but generate a better return on parked money.

When it comes to an alternative to a savings account, people usually go for Liquid Funds available. But, is the liquid funds are a good alternative to a savings account? Let’s find it out but before;

What Are Liquid Funds?

Liquid Fund is a type of Debt Mutual fund that pools money from the investors and invest in short term market instruments like, government treasury bills, commercial papers, corporate bonds. The maturity of the liquid funds are between 1 to 91 days only. They don’t have any lock-in period which means, you can sell it at any time.

Liquid Funds don’t offer higher returns but usually generate more returns than the savings account. Since they don’t hold any bond or investment for more than 91 days therefore chances of NAV (Net Asset Value) fluctuation or market risks are very less. You have two options with liquid funds i.e. Growth Funds which reinvest the returns and Dividend which gives dividends on a daily, monthly, or quarterly basis.

One should never consider the Liquid Funds for investment but should be used for parking the excess money.

Unlike other debt funds, liquid funds shouldn’t be used as an investment instrument rather it should be considered a safe way to park your excess money. This will give the flexibility to use it whenever the fund requirement arises and at the same time, you can earn more returns.

Are Liquid Funds Risk-Free?

Liquid Funds invest money in short term market instruments like government treasury bills, commercial papers, corporate bonds, and investment returns are based on the money made of these instruments. Therefore, if any of the companies default to goes bankrupt, the losses will reflect on your liquid funds NAV.

But, Liquid Funds only invest in instruments that have a maturity period of 1 to 91 days, and fund managers usually hold the investment until maturity. Since the duration is very short, the risk of market fluctuation or interest rate change is almost negligible. Most of the liquid funds invest only in highly rated instruments which results in a steady performance.

In a nutshell, Liquid Funds have very minimum risk provided you have invested in good liquid funds.

The following chart (credit moneycontrol.com) represents the performance of a liquid fund in India from June 2010 to June 2020. It has given more than a 7% annualized return over the time and doesn’t show the effect of a market correction in the year 2013, 2016, and 2020.

But, since the liquid fund investments are linked to the market performance therefore, it is not 100% risk-free like a savings account or fixed deposit.

Are Liquid Funds Better Than Savings Account Or Fixed Deposit?

Yes! Liquid Funds are better than Savings Account is invested with discipline. Liquid Fund returns are not guaranteed but if you look at the past performance of such funds, they all have generated returns from 5% to 8% per annum.

Interest gain on the savings accounts are added to your gross income if crosses INR 40,000 in a financial year and taxed as per your income tax slab. On the other hand, taxes on the Liquide fund returns are based on whether it falls under short term capital gain or long term capital gain. For Short Term Capital Gain, it will be added to your annual gross income and taxed as per your income tax slab and if it falls under Long Term Capital Gain then you get the benefit of indexation and pay 20% flat tax on Inflation Adjusted profits.

As I explained earlier, Liquid Funds should be used to park the excess funds as we do in the Savings account. Your intentions should not be getting higher return rather, it should be to safely park your money and generate little more than the savings account. You can always go for mutual funds, equity investment, or short/long term debt funds for investment purposes.

But, if you compare it with Fixed Deposit then I wouldn’t agree that Liquid Funds are a better investment than FD. Fixed Deposit guarantees the fixed return and it is a risk-free investment. But I would prefer the other debt fund like Short Term or Long Term Debt funds over FD because these funds are more stable, flexible, and perform well in the long run.

Banks are providing fixed deposit facilities for as low as 7 days but the interest rates offered on these FDs are very low. The following are the latest interest rates on the Short term and Long term FDs of ICICI Bank.

Liquid Funds provides the flexibility of savings account but generate the returns similar to Fixed Deposit and sometimes even more.

What About The Debt Fund Liquidity?

Savings Account comes with the highest liquidity i.e. you can withdraw money almost anytime. You can use an ATM to withdraw money for your fund requirements.

In the case of Liquid Funds, you have a request for redemption at least 1 day before the fund gets credited to your linked account. However, many reputed funds houses are providing instant redemption facilities also that makes the liquid funds more desirable.

When Should We Invest In Liquid Funds?

Now, we know about Liquid Funds, how liquid fund works? Advantages and Disadvantages of Liquid Funds. Let’s see when should we invest in a liquid fund?

  • When you have excess funds in your savings account and you don’t have any big expenses in the coming month or two.
  • You want to keep emergency funds aside. Instead of keeping in a savings account and getting a poor interest rate, better keep in a liquid fund and enjoy good returns until you require emergency funds.
  • You have received your pension amount or maturity amount from other investments like PPF, FD, Life Insurance, etc. Until you decide, where to invest this money next, park it in a quality liquid fund.
  • You are waiting for the right moment in the market for investment but not sure about the duration.

You should always keep your monthly expenses, insurance premium, or upcoming shopping fund in your savings account.

Top 3 Tips To Find The Best Liquid Funds

Your return on investment in Liquid Funds depends on how the fund performs, therefore it is crucial to choose the quality liquid fund to get more benefit or stay risk-free. Following are some tips you can use in your debt fund selection criteria;

  1. Only invest in the highest-rated funds: Credit Agencies give ratings to each fund based on their investments and past performance. We can utilize the credit rating as one of the Selection Criteria.
  2. Check fund’s investment i.e. portfolio: You should always check for the fund’s portfolio and invest in a fund that has an investment in government bonds or treasury bills. Avoid funds that are investing in a bond issued by small or financially unstable companies.
  3. Check AUM i.e. Asset Under Management: You must check the total AUM value of a fund and select funds that have high AUM values. Such funds invest in many bonds and have proper diversification. well managed and diversified bonds have very minimum risk and promise steady and consistent returns.

Liquid Funds are better than saving accounts but one should select the best performing liquid fund and understand their investment goals. Liquid funds should be used to park your excess money or emergency funds only and should not run after low quality but high paying liquid funds. You should be happy even if you are getting 2 or 3 percent more returns from your savings account and invested in a high quality liquid funds.

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I hope, your doubt regarding the liquid funds is clear now and it will help you decide whether to keep money in a savings account or liquid fund. Both account have their pros and cons and you should use them as per your requirements. Let me know if you find this article helpful and also feel free to ask any questions if you have any?

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