Liquid funds can be a alternative to savings accounts

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For quite some time now, savings bank deposits have been the preferred option to park surplus cash. Most retail investors regard this as the only avenue that provides best liquidity and safety of capital at the same time, which also helps them earn a little bit of interest income. However, there is an option that offers better returns than savings accounts, without affecting liquidity much. They are known as liquid funds.

What are liquid funds?

Liquid funds are open-ended money market mutual fund schemes that invest in call money market and other fixed income securities with a maturity period of less than 91 days. The fund manager puts liquidity and safety as the basic tenets while constructing the portfolios of these funds.

They are least risky as well as least volatile in the category of mutual funds for the following reasons:

·         For one, they mostly invest in instruments with high credit rating.

·         Two, the NAV of liquid funds is not volatile as the only change in their NAV is mostly as a result of the interest income that accrues. This makes these funds a safer place to park your money.

The liquidity needs of investors are not at all compromised. For, all redemption requests submitted and timestamped before the cut-off time, the payouts are made the very next day — this is also known as redemption on a T+1 basis.

Higher Returns than Bank SB Account

To let your surplus money remain idle in a savings bank account is a bad investment decision when the same can be invested in liquid mutual funds which offer higher interest rates. Besides, one does not have to compromise much with liquidity.

In spite of RBI’s deregulation of savings bank interest rate, only a handful of banks offer 6-7% interest on savings accounts, while most banks are still offering you only 4%. Now, rather than planning to switch loyalty to banks offering higher savings deposit rate and bothering yourself with the hassles of opening a new account, you should consider putting your surplus money in liquid funds.

In the current high-interest rate scenario, the category of liquid mutual funds has delivered annual returns of 9.5% and 8.7% for the calendar years 2012 and 2011, respectively. In fact, the minimum return given by any liquid fund during these calendar years was 7.4% for 2012 and 6.7% for 2011, which is still much higher than the 4% interest rate offered on your savings deposit.

More Tax efficient

Liquid funds also offer a tax advantage over savings deposits. For dividend plans, dividend distribution tax (DDT) on liquid funds is 28.325%, while the interest on a savings bank account is added to an individual’s income and taxed at the rate applicable. This means if you are in the highest tax bracket, you will pay a tax of 30.9% on your interest from savings deposit.

Similarly, in case of the growth option, returns from liquid funds would attract long-term capital gains if redeemed after a year (10% without indexation and 20% with indexation plus cess). This favourable tax treatment (see chart) means that the post-tax returns on liquid funds are likely to be higher than interest earned on savings bank accounts.

Carry out basic checks

Liquid fund is an alternate investment avenue to park your short-term surplus funds. While savings deposits are easier to access and offer some degree of principal protection, the higher yield combined with the liquidity and taxation benefits make liquid funds an attractive option.

However, liquid funds are not risk-free, and an investor must carry out basic checks before investing. Moreover, investors must spread their savings across savings bank accounts and liquid funds, thereby enjoying the benefits each of these avenues have to offer.

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