Savings accounts have long been a popular choice for individuals to park their surplus funds, offering easy access and minimal risk. However, in recent years, liquid funds have emerged as a viable alternative to savings accounts, raising the question: Is a liquid fund better than a savings account? Let’s delve into the details:
Easy access to money
Liquidity is a key factor that most individuals consider while choosing an investment option. Savings accounts allow you to withdraw funds whenever needed without any penalties. Liquid funds, which are a type of mutual fund, offer similar liquidity features. You can withdraw funds instantly or within a short period, typically between one and three business days, depending on the fund’s terms and conditions.
Return on investment
Another important aspect to consider is the return on investment. Savings accounts offer modest interest rates which may not keep pace with inflation. On the contrary, liquid funds have the potential to generate higher returns due to their investment in short-term money market instruments such as treasury bills, commercial papers, and certificates of deposit. These instruments offer relatively higher yields compared to the interest rates of savings accounts. However, returns from liquid funds are subject to market fluctuations, and there is a degree of risk involved.
Adhil Shetty, CEO, Bankbazaar.com, says, “Equity funds buy stocks in high-performing companies. Debt funds invest in the government and corporate bond markets. Liquid funds invest in money market instruments and highly liquid debt instruments, such as treasury bills issued by the Government of India. LMFs have the reputation of sometimes providing marginally higher returns than bank deposits. Being a smart saver is about gauging out an extra percentage or two in interest without taking undue risks. There are many ways to do this. Liquid mutual funds are one of them.”
“As far as savings accounts are concerned, you can choose from government banks, private banks, small finance banks, cooperative banks and even the humble post office. A savings account provides easy accessibility to money and protects your liquidity,” he adds.
Risk is an essential factor to evaluate when comparing savings accounts and liquid funds. Savings accounts are considered low-risk instruments as they are typically insured by government-backed deposit insurance schemes. In contrast, liquid funds are market-linked instruments and are not guaranteed. While they invest in low-risk money market instruments, there is always the possibility of a slight fluctuation in the net asset value (NAV) of the fund, resulting in minor capital losses. However, liquid funds are relatively less risky compared to other mutual fund categories, such as equity funds.
Taxation is another factor to consider. Interest earned from a savings account is considered as ‘Income from Other Sources’ and is taxable as per an individual’s income tax slab. The interest earned is added to the individual’s total income and taxed at the applicable income tax rates.
If the holding period of the liquid fund investment is less than three years, any gains are considered as short-term capital gains. These gains are added to the individual’s total income and taxed as per the applicable income tax slab rates.
Diversification of investment
Diversification is an advantage offered by liquid funds. When you invest in a savings account, your funds are essentially parked with a single bank. In contrast, liquid funds invest in a portfolio of money market instruments issued by different entities, offering diversification benefits. This diversification helps in spreading the risk across multiple issuers, reducing the impact of any default by a single entity. Therefore, liquid funds can provide a slightly higher level of safety compared to savings accounts.
Both savings accounts and liquid funds have their own set of advantages. If liquidity and safety are your primary concerns, a savings account may be a suitable option. However, if you are willing to take a slightly higher degree of risk for potentially higher returns, along with added diversification, then liquid funds can be a viable alternative. It is important to assess your financial goals, risk tolerance, and liquidity requirements before making a decision.
- Liquid funds can generate higher returns due to their investment in short-term money market instruments
- One can withdraw money instantly or within one and three business days from such funds
- Assess your financial goals and risk tolerance before making a decision