What are Liquid Funds?
Debt Mutual Funds that predominantly invest in debt securities with short term maturities, that yield fixed returns are known as Liquid Funds. These debt securities comprise money market instruments such as treasury bills, commercial paper, certificates of deposits with maturity period up to 91 days.
The fundamental advantage of investing in liquid funds is the high liquidity they offer. Liquidity refers to the degree of how quickly an asset can be bought/sold and converted to cash.
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What is a Savings Account?
A Savings Account is one of the most popular financial services products in the country. For years, Indians have always parked their surplus cash in savings accounts owing to the safety of funds they offer. Also, withdrawal can be made from such accounts as per the requirement of the investor, owing to cheque and ATM card facilities.
However, the rate of interest offered by these accounts is minuscule, which makes them less of an investment option and more of a safe place to keep your money.
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Liquid Funds v/s Savings Account
- Liquidity
One of the primary reasons why liquid funds and savings accounts are often compared is the liquidity they offer. It is a well known fact that money parked in savings accounts is in its most liquid form, after currency notes.
Typically, mutual funds are not that liquid, because of reasons such as high risk associated with short term investment in equity funds, exit load levied on early withdrawal, etc. However, a category of mutual fund scheme known as Liquid Funds is specifically designed to cater to this drawback. Investment in these schemes is highly liquid as investors can withdraw the invested capital as per their convenience and need. After 7 days of investment, there is zero exit load charged on withdrawal. Some of the mutual fund schemes also offer 24*7 instant redemption facility, wherein the amount gets credited into the bank account of the investor within minutes.
- Return on Investment
When we compare the returns from investment in savings account and liquid funds, there is a significant difference. While the interest rate offered by savings accounts hovers around 4-5%, liquid funds have delivered returns exceeding 7% over the years. In addition to the liquidity offered by the fund, better returns than that from savings accounts make liquid funds a preferred alternative to savings accounts. However, it should be noted that a good historical performance is not an indicator of better future performance, in case of mutual funds.
Also, Liquid Funds are a good investment option to build an emergency fund, which will give extra returns as well, in addition to keeping the principal intact.
- Risk Exposure
Money parked in bank savings accounts is safe from any kind of potential loss, and the returns are predetermined. This makes them one of the least risky financial instruments available in the market. On the other hand, Liquid funds are not entirely risk free. Though miniscule, the possibility of interest rate fluctuations negatively affecting returns and issuer of the debt security defaulting on the payment. These are known as interest rate risk and credit risk respectively.
- Taxation
Interest earned upto ₹10,000 from savings accounts is exempted from any taxation. If the interest yield is more than ₹10,000 in a year, the additional amount is added to the taxable income of the investor and taxed as per his/her income tax slab rate.
In case of liquid funds, if you withdraw the funds before three years of investment, Short Term Capital Gains Tax is levied as per the income tax slab of the investor. If the fund units are held for more than 3 years, Long Term Capital Gains Tax of 20% is levied, with the benefit of indexation.