All of us have bank accounts and most of us even have a surplus amount lying in that account. The first step to financial planning is having an emergency fund. It should cover at least a minimum of 3-6 months of expenses. It is usually advised to keep this amount in the savings bank account as it is considered most liquid. Also, it can earn up to 3% interest per annum. But what if I say there are better ways to earn a higher interest rate on the emergency fund and is considered the next best liquid alternative to a savings account. This article explains about the Liquid Funds vs Savings Account.
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What is a Savings Bank Account?
Savings Account in different banks in India offers interest rates varying from 2%-4%. On average, most banks offer 2%-3% and the same would be used throughout the article for comparison. A savings account is considered the most liquid form of investment with immediate redemption. It is as good as having cash in hand but stored in a safe place. A savings account is risk-free. The interest earned is assured. Also, the banks do no change the rates frequently and are consistent over a period of time. The interest earned on a savings account is tax-free till Rs 10,000 and TDS threshold is Rs 40,000 (to be implemented from April 1st, 2019). However, this interest income is still taxable as per individuals tax slab.
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What are Liquid Funds?
Liquid Funds are debt mutual funds that invest in very short-term market instruments such as government securities, treasury bills, and call money. They invest in low-risk securities. Their average maturity is much lower than any of the funds. They invest in securities which have maturity up to 91 days. Also, the average return of liquid funds is around 5%-6%. If you are looking at investing your surplus money for a short time and worried about locking your money in fixed deposits then liquid mutual funds are the right thing for you.
Benefits of Liquid Funds
Liquid funds offer the following benefits:
No lock-in period: Liquid funds do not any lock-in period.
Easy redemption: Redeeming liquid funds is very easy and the money will be credited in 1-2 days in the individual’s bank account.
Lowest interest rate risk: Of all the debt funds available in the market liquid funds have the least interest rate risk.
Better returns than a savings account and FD: One can expect a return of 5%-6% from liquid funds per annum which is better than savings bank interest (2%) and return from FD (4%). Also, the returns post inflation from liquid funds is higher than from a savings account and FD Investment.
No minimum balance required: In savings bank account one has to maintain a minimum balance. But with liquid funds, there is no limit on minimum or maximum investment.
Different plans available: Liquid funds are available for different time periods like daily, weekly, monthly, dividend and growth plans. One can choose any plan based on their requirements and tenure.
It is very clear from these benefits that investing in liquid funds is very beneficial than leaving the money idle in a savings bank account.
Difference Between Liquid funds and Savings Account
The following table summarizes the key differences between liquid funds and savings account:
|Basis of Difference||Liquid Funds||Savings Account|
|Rate of Return||7% to 8%||4%|
|Returns||More or less stable returns.||Guaranteed return.|
|Risk||Low risk, subject to interest rate risk and credit risk.||Risk-Free|
|Lock in Period||No Lock-in period||No Lock-in period|
|Liquidity||Highly Liquid||Highly liquid, equivalent to holding cash.|
|Minimum Balance||No such restriction||Banks have a minimum account balance restriction and vary from bank to bank.|
|Taxation||Depending on the investment holding period, you will have to pay capital gains tax. If the investment holding period is less than three years, the short-term gains are taxable as per the investor’s income tax slab rate. If the investment holding period is more than three years, the long-term gains are taxable at 20% with indexation benefit.||Interest above INR 10,000 is taxable. The gains are added to your taxable income and are taxed as per your slab rate.|
|Suitable for||Investors who wish to generate higher returns than a savings account.||Investors who want to park their money in a bank.|
|Where to Open||Through a fund house (AMC) or distributors and online platforms.||With a bank.|
Liquid Fund Vs Savings Account: Which is Better?
The choice between a savings account and a liquid fund largely depends on the investor. Though both options are safe, liquid funds offer higher growth. Many experts recommend investing in liquid funds over savings accounts because they are highly flexible and have no penalties or exit loads. Additionally, liquid funds often have higher interest rates and can sometimes offer double the returns compared to traditional savings accounts. Furthermore, some AMC offers ATM access to withdraw money. The only downside for liquid funds is that it may take one to two business days to access the funds.
Frequently Asked Questions
Liquid funds invest in debt instruments with a maturity period of less than 90 days.
Liquid mutual funds charge an exit load only when the units are redeemed within 7 days from the date of investment. The exit load varies between 0.0070% to 0.0045% of the redemption amount.