Bank fixed deposits have been the most popular place in India for decades to invest short-term funds, but liquid funds are now emerging as one of the top substitutes.
To make effective investment decisions, it is important to know the manner in which liquid funds will prove to be more advantageous for investors than bank deposits. Even as FDs guarantee return certainty, liquid funds can still provide higher liquidity, and in certain cases, tax efficiency too. Read on to know more:
Understanding the basics of liquid funds
First, let us know what liquid funds are. They are a mutual fund investing predominantly in extremely short-term debt securities such as: Treasury bills, commercial paper, and certificates of deposit. Since they invest in short-term securities, this makes them very stable, efficient and liquid.
Key advantages of liquid funds over bank deposits
- Possibility of greater returns: Whereas bank deposits receive some interest at a certain rate of interest, liquid funds enjoy the possibility of higher returns. Liquid funds invest in extremely short-term debt instruments like treasury bills, commercial papers, and certificates of deposit. Although returns are not guaranteed and are market-dependent, the guarantee of higher returns renders liquid funds a money for value investment for investors.
- Higher liquidity & availability: Liquid funds are highly liquid in nature, and the funds can be withdrawn at any time. Further, the funds are credited to the bank account within 24 hours. Bank deposits on the other hand have a lock-in period, and early withdrawal will attract reduced overall returns or associated charges. Liquid funds hence have a significant advantage over bank deposits because of easy use flexibility.
- Tax efficiency: Liquid funds are an income tax effective option to bank deposits, particularly for high tax paying investors. Income from liquid funds is charged with income tax in the slab of the investor but only on profit. Interest earned on bank FDs is taxed at the investor’s income tax slab for the entire amount, depriving the investors of the take-home returns in the event of higher slabs of taxes. In addition, if the money is left in liquid funds for over three years, it is taxed at a reduced rate of 20% with indexation benefit.
- Liquid funds can also act as emergency funds: Due to their liquidity and fixed returns (though not assured), liquid funds are a perfect destination to park your corpus for emergencies, they can hence also act as emergency funds. The investors can withdraw the funds on short notice in case of any urgent financial need without incurring penalty charges. Liquid funds can be utilised to invest your corpus for emergencies since they are readily available when needed.
- Lower exit loads: Unlike some of the other schemes of investment, liquid funds don’t charge much or any exit load (charges of redemption). That is to say, your money comes back to you with very little processing charge, which can come as a relief in comparison to some type of fixed deposit where you are charged for previous withdrawal.
Some of the leading liquid funds are: Mahindra Manulife Liquid Fund, Aditya Birla Sun Life Liquid Fund, Quant Liquid Fund among others. The returns for these funds have varied between 5 to 7% over the last 3 years. Therefore, these funds provide competitive returns and can be considered as an investment option upon proper consultation with your financial adviser.
Hence, liquid funds have some advantages over bank deposits such as higher potential returns, easy accessibility, tax efficiency in some cases, standby money suitability, and low exit fees. Knowledge of these benefits will enable investors to make informed decisions on where to place their short-term funds and achieve the best returns.
Disclaimer: Mutual fund investments are subject to market risks; please read all scheme-related documents carefully before investing.
