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Got money to invest, but finding it difficult to choose between the stability of fixed deposits and the returns that liquid mutual funds offer? Well, you are not the only one. Picking a side in the liquid funds vs fixed deposits fight is indeed tricky.  Especially, if you consider the various advantages both these investment options have. Ideally, you should base a decision about investment options on your financial goals. However, if you are new to financial investments, exploring topics like what are liquid funds can be a good place to start.

Liquid Funds vs Fixed Deposit (FD): Key Differences

In case of liquid mutual funds, your corpus is professionally managed by the fund house and fund managers.

As financial markets move in tandem with economic ups and downs, mutual fund schemes like liquid mutual funds also benefit from any such booms.

The following table summarizes the key differences between liquid funds and fixed deposits:

Basis of DifferenceLiquid FundsFixed Deposit
ReturnsHigher than fixed depositLower
SuitabilityShort term and long term investorsShort term and long term investors
RiskMediumLow
Premature WithdrawalYes, with low penaltyYes, with high penalty
Minimum InvestmentLowHigh
Tenure7 days to 91 days7 days to 10 years
TaxationIf investment horizon is less than three years, the short term capital gains are added to the total taxable income.If the investment horizon is more than three years, the long term capital gains are taxable at 20% with indexation benefit. Attracts 10% TDS if interest income exceeds INR 10,000 per annum. Interest is added to the total taxable income and is taxable as per the applicable slab rate.

Read also about the Arbitrage Funds Vs Liquid Funds

What are Liquid Funds?

Before jumping straight to the liquid funds meaning, let’s find out what are mutual funds. Mutual funds are investment tools that pool money from investors and invest it across either different asset classes or companies of varying market capitalization. The investor earns money either by way of dividend income or capital gains.

Liquid funds are one of the many types of mutual funds. At the same time, if you want to know more about mutual funds in general, then there are several articles available online to help you out.

Coming to liquid funds meaning, you should know that this option is a short-term investment tool.

In liquid funds, an investor’s money is ploughed into debt-based securities and fixed income earning instruments like treasury bills, call money and commercial papers for a period of up to 91 days. What’s more is that whenever an investor wants to redeem his/her money, the amount is credited to their bank accounts within 24 hours.

In case you feel that you could use some more information about liquid funds before you go ahead with this option, you could search online for more resources.

What is a Fixed Deposit?

Before you choose a side in the liquid funds vs FD match, it is important that you familiarize yourself with fixed deposits too.

You might have often heard your parents lauding bank fixed deposits as a great saving tool and sometimes even encouraging you to do the same. Well, they are right. Fixed deposits have been catering to people’s savings requirement for decades.

FD Investment is a saving mechanism, wherein you park your money away for a few years in a bank. The money cannot be withdrawn for a certain period, which is called the lock-in period. Unlike liquid funds returns, the bank pays you interest on the money annually and you can withdraw it after the lock-in period ends.

Now that you are better informed about what are liquid funds and fixed deposits, let’s move on to their pros and cons.

Advantages and Disadvantages of Liquid Funds

Advantages

  • Liquidity: For starters, a liquid fund is one of the most flexible types of mutual funds, because of short lock-in periods. They come with a greater degree of liquidity. If you are not too keen on long-term investments but don’t want to let your money sit in a savings account, then these are for you.
  • Capital gains: In liquid funds vs FD, these mutual fund schemes also have an edge over fixed deposits. In a fixed deposit, you might earn interest on the principal amount, but it is more or less fixed. The principal itself doesn’t grow. In the case of short term liquid funds, the corpus you invest grows by way of capital gains and dividends earned.
    If you are looking for more pointers to invest in other types of mutual funds, there are some informative guides available online to make your concepts clearer.
  • Lower volatility: As the lock-in period for short-term liquid funds is only up to 91 days, they tend to be less volatile as compared to other types of mutual funds.
  • No exit load: Unless you redeem your money within seven days of investing, you wouldn’t have to pay any exit or entry load on your investment.
  • Higher growth rate: These funds give you a chance to earn higher growth rates on a lower-risk investment. Take savings accounts for instance. The savings account offers you an interest rate of 3-4%, whereas liquid mutual funds returns on investments range from 6% to 7%.

Disadvantages

  • Tax on Liquid funds: The capital gains accruing from these schemes are taxable. If you have been investing in liquid funds for a period of more than three years, then a Long Term Capital Gains Tax (LTCG) would be levied on these. For that matter, India has an extensive taxation system for various kinds of mutual funds.
    On the other hand, if your corpus is invested for a period of fewer than three years then the liquid mutual funds tax would depend on your income tax slab. They do not offer any tax exemptions.
    For a comparative analysis between liquid funds and other types of mutual funds, look up for such articles online.

Advantages and Disadvantages of Fixed Deposits

Advantages

Unlike a decision to invest in liquid funds, an investment in fixed deposits is a low-risk one.

Disadvantages

  • There is no such thing as an FD tax exemption. Any interest income above Rs 10,000 is subject to a 10% tax deducted at source.
  • Apart from tax on fixed deposits, the returns on fixed deposits are generally fixed and not too high.
  • In case of unseen circumstances like a calamity or a financial emergency, a Bank fixed deposit is insured only up to Rs 1 lakh.

Liquid Funds Vs FD: Which is Better?

The goal of investing in FDs is different than that of liquid funds. FDs may not provide returns that beat inflation, but they offer a higher level of safety and have strict lock-in periods. Liquid funds offer better returns and more liquidity than FDs, as well as the benefit of indexation to account for inflation. The choice between liquid funds and FDs is a topic of debate among conservative investors, but more and more are recognizing the wealth-building potential of liquid funds over FDs. Ultimately, the choice depends on your portfolio and financial goals.

Top-Performing Liquid Funds

While there’s no dearth of liquid funds, here are a few schemes which posted an impressive performance in 2019 as per Scripbox:

Axis Liquid Fund

Launched on January 1, 2013, this scheme comes with a low-risk grade but its return grade is above average. With a three-star rating from Crisil, the liquid funds returns here is 8.04% since launch. Its expense ratio is 0.11%.

Tata Liquid Fund

Earlier known as Tata Money Market Fund, this scheme was launched on September 1, 2004. In this case, a decision to invest in liquid funds comes with a low-risk grade and above-average returns. Its growth rate since launch has been 7.63% and an expense ratio of 0.27%. It enjoys a three-star rating from Crisil.

Final thoughts

Are liquid funds safe? That’s a question a lot of investors ask their fund managers. While the answer might vary from person to person, given the high degree of liquidity and low risk that comes with these funds they are a pretty reliable investment tool. There are several other blogs on Scripbox which can educate you about the key differences between fixed deposits and mutual funds.

However, if you think you need more prepping before you dive into something like short term liquid funds, then educate yourself with any of the guides that are available on the internet. You can also Fixed Deposit Calculator to calculate the investment return and Fixed Deposit rate of return on your investment to know your maturity amount.

Frequently Asked Questions

Can I lose money in liquid funds?

Liquid funds are known for low risk. These schemes invest in short duration instruments with high ratings. Thus, the risk of losing money is almost zero.

When does a liquid fund mature?

Liquid funds invest in instruments with a maturity of up to 91 days. Thus, the fund’s maturity is up to 91 days.

Can I invest INR 50 lakh in FD?

Yes. There is no limit on how much you can invest in an FD.

Can I add money to the fixed deposit?

No. You cannot add money to an ongoing FD. You can always start a new FD.

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