Liquid Funds vs Savings A/c
For any individual who has started their financial planning journey, building and maintaining an emergency fund is the first step. However, when choosing a financial product for the emergency fund, there is often a debate on Liquid Funds vs Savings A/c. This article will discuss the pros and cons of both these financial products to assess which one an investor should select.
A liquid mutual fund is an open-ended scheme that invests its money in debt and money market securities with a residual maturity of up to 91 days only. SEBI has classified liquid funds under the broader category of debt schemes. Some of the financial products that liquid funds invest in include:
- Treasury Bills (T-Bills)
- Commercial Paper (CP)
- Certificate of Deposit (CD)
The objective of liquid funds
Liquid funds are considered to be safer as compared to other mutual fund schemes. The objective of liquid funds is to provide steady returns along with safety and liquidity to investors.
- Mode of investment
An investor can invest in liquid funds through a lump sum or a systematic investment plan (SIP).
Table: Liquid mutual funds - Category average returns
|Details||1 year returns||3 year returns||5 year returns|
|Category average returns||3.11%||4.50%||4.86%|
|Year-wise category average returns||3.45%||5.30%||5.49%|
Note: The returns are as of 30th June 2021 and sourced from www.mutualfundindia.com
- Instant redemption
Some AMCs provide the instant redemption option to investors of liquid funds. The amount is transferred to the investor’s bank account through IMPS. The redemption is allowed for a specified amount (for example, 90% of the balance available or Rs. 50,000, whichever is lower).
- No lock-in
Liquid funds don’t have any lock-in period. So investors are free to withdraw whenever they want. However, there may be a small exit load if units are redeemed within the first seven days of investment.
Liquid funds fall within debt mutual funds and hence are taxed accordingly. If the holding period is less than three years, the profits will be classified as short-term capital gains (STCG). The STCG will be added to the investor’s overall income and taxed per their income tax bracket.
If the holding period is more than three years, the profits will be classified as long-term capital gains (LTCG). The LTCG will be taxed at 20% with indexation benefit.
For example, Chetan invested Rs. 50,000 in a debt mutual fund in 2014. He redeemed his investment in 2018 for Rs. 66,000.
To calculate the long-term capital gains tax, we will have to calculate the inflation-indexed purchase price. The cost inflation index (CII) is notified by the Government every year. The CII for 2014 was 240 and for 2018 was 280.
Indexed cost of investment = 50,000 x (280/240)
= 50,000 x 1.166667
= Rs. 58,333.33
Long-term capital gains = Redemption value - Indexed cost of investment
= 66,000 - 58,333.33
Long-term capital gains tax with indexation benefit = 7,666.667 x 20%
= Rs. 1,533.333
Chetan will have to pay a long-term capital gain tax of Rs. 1,533.33 after availing the indexation benefit.
Liquid funds are an ideal investment product for any investor to build and maintain their emergency fund.
- Savings account
A savings account is an interest-bearing account that you can open with a bank or a post office. You can deposit, maintain, and withdraw money from the savings account whenever you need it. A savings account is the most basic type of account that an individual can open with any bank.
You can use a savings account for various transactions. For example, you can use a debit card for withdrawing cash from ATMs. You can also use it for offline transactions at merchant outlets and online transactions. In addition, you can pay utility bills and do other regular transactions. Apart from payments, you can use a savings account for making investments into mutual fund systematic investment plans (SIPs).
The bank pays you interest on the balance maintained in the savings account. The interest is calculated daily on the closing balance. It is credited to your savings account at the end of the quarter. Banks are free to determine the interest rate payable on savings accounts. However, banks pay an interest rate in the range of 1.5-7.5% p.a. on savings accounts.
Table: Savings accounts - Interest rates of some banks
|Bank name||Interest rate range depending on the balance maintained|
|Utkarsh Small Finance Bank||5-7.25% p.a.|
|AU Small Finance Bank||3.5-7% p.a.|
|RBL Bank||4.5-6.25% p.a.|
|Bandhan Bank||3-6% p.a.|
|Yes Bank||4-5.5% p.a.|
|IndusInd Bank||4-5.5% p.a.|
Note: The interest rate is on 10th June 2021 and has been sourced from respective bank websites.
- Taxation of interest
The interest earned on a savings account qualifies for a deduction from taxable income. For senior citizens, the deduction is up to Rs. 50,000/financial year, under Section 80TTB of the Income Tax Act. For other individuals, the deduction is up to Rs. 10,000/financial year, under Section 80TTA of the Income Tax Act.
The remaining interest is added to the investor’s overall income and taxed as per the income tax slab that they fall in.
Liquid funds vs savings account
We have discussed the features of liquid funds and savings accounts. Now, let us make a comparison of both:
|Feature||Liquid funds||Savings account|
|Risk||Liquid funds are subject to market risks. Thus, although they carry low risk, they are relatively riskier than savings accounts.||Savings accounts are not subject to market risks. As a result, they are relatively safer than liquid funds.|
|Insurance||There is no insurance available in case of liquid funds.||The savings account balance of up to Rs. 5 lakhs is insured by Deposit Insurance and Credit Guarantee Corporation (DICGC) of India.|
|Returns||Liquid funds have the potential to provide better returns as compared to savings accounts.||Banks pay 1.5-7.5% interest p.a. on savings accounts. Most big banks pay 2.5-3% interest p.a. on savings accounts. This interest rate is lower than the returns that liquid funds can generate.|
|Minimum balance requirement & non-maintenance charges||Liquid funds have no minimum balance requirements to be maintained. Hence, there are no balance non-maintenance charges.||Savings accounts have minimum balance maintenance requirements ranging from Rs. 0–25,000 or even higher, depending on the type of savings account chosen. If the minimum balance is not maintained, then the bank levies balance non-maintenance charges.|
|Tax efficiency||The LTCG is charged at 20% with indexation benefit. Thus, liquid funds are more tax-efficient than savings accounts.||In a financial year, the interest of up to Rs. 10,000 is eligible for deduction under Section 80TTA. The remaining amount is added to the investor’s overall income and taxed per their income tax slab. An investor in the 30% tax bracket will be paying more tax on interest income than a liquid fund investor who will have to pay 20% LTCG with indexation benefit.|
Based on the above comparison table, liquid funds have an advantage over savings accounts on parameters like returns, no minimum balance requirements, and tax efficiency.
Risks of Investing in Liquid Funds Vs Savings Account
Savings bank accounts have almost no risks attached to them. They don't have to worry about market or credit risks. Liquid funds are not completely risk-free, but they are low-risk low-return investments. They are exposed to interest rates and credit risks because they invest mostly in debt products. A difference in the price of debt instruments could result from a change in the current interest rates. This may cause the liquid fund's NAV to fluctuate as a result. Liquid funds' NAV may not fluctuate dramatically because they invest mostly in short-term debt instruments.
How to invest in a liquid fund vs savings account?
An investor may split their funds between a savings account (65%) and a liquid fund (35%). These days, most banks offer the facility to open a savings account online. You can open it by submitting PAN and Aadhaar numbers online and video KYC (Know Your Customer). Once the savings account is activated, you can fund it through an online transfer.
Setting up the emergency fund with Glide Invest.
You can set up your emergency fund with a liquid fund SIP using the Glide Invest App. The App allows you to invest in direct plans and save commission expenses. You can take the following steps:
- Open the App and select the Emergency Fund goal
- Enter the desired amount that you would like to accumulate for your emergency fund
- Select whether you wish to invest a lump sum amount or start a systematic investment plan (SIP)
- If you select the SIP option, then you will need to enter the amount that you would like to save every month for your emergency fund.
- Choose the SIP date
- Make the payment through net banking, UPI, or set up AutoPay (your monthly SIP amount will be auto-debited from your bank account)
Q1: Is it better to have liquid funds than a savings account?
A1: Liquid plans may be a good method to save money and increase your money, depending on your risk profile and current assets. To minimise risk to a bare minimum, it may be prudent to keep your savings account open and invest in a small number of liquid assets.
Q2: What is a liquid fund's advantage?
A2: Liquid funds are ideal for investors looking to keep excess assets in a safe place for a short period of time. Superior returns, safety, high liquidity, no lock-in period, and other benefits are all available with liquid funds.
Q3: Is it possible for me to lose money with liquid funds?
A3: One of the safest mutual funds is liquid funds. This is because they lend to good companies for very short periods of time, which decreases risk. If you stay involved for a long period, the chance of losing money is essentially non-existent.
Q4: Is it possible for liquid funds to generate negative returns?
A4: The value of liquid funds may decrease. However, because to the strict controls, the risk of them depreciating in value is low. But, if that happens, the size of the drop could be minor, and it could recover in seven to eight days.