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Is Liquid Fund A Safe Alternative To Savings Account?

Adhil Shetty

Liquid funds can help you earn better interest rates than saving bank accounts without compromising much on cash withdrawal time. Read on to know more about its features.

Is Liquid Fund A Safe Alternative To Savings Account?

Saving bank accounts are popular with people as they are considered to be a safe investment. Even after the RBI deregulated interest rates on Savings Account, most banks offer around 4%. Some private banks do offer 6%, but that’s only if the minimum deposit is as high as Rs. 1 lakh. Despite Savings Account yielding low interests, people still prefer to park a significant proportion of their funds in the bank because of its liquid nature and pay less attention to other high yielding investing options.

Liquid funds are one such option that can help you earn better interest rates than saving bank accounts without compromising much on how quickly cash can be withdrawn.

What Is Liquid Fund?

Liquid Fund is a type of Debt Mutual Fund that primarily invests in money market instruments such as treasury bills, certificate of deposits, commercial papers, government securities, inter-bank call money and term deposits having a maturity of less than 91 days. Liquid Fund is convenient and a cost-effective investment, that provides liquidity and safety of capital along with moderate returns. These come in various dividend options like – daily, weekly, monthly and growth option. The risk attached to this investment instrument is low as the fund manager plays with high credit rating securities in the portfolio.

Liquid Fund Vs Savings Account

Bank Savings Account is considered as the safest and hassle-free investment, as it is not subjected to any market risks or is affected by fluctuations in the capital market. The only worry is the low-interest rates that it offers. Liquid funds are riskier as compared to savings bank account, as its NAV (Net Asset Value) fluctuates on a daily basis. However, on returns perspective, it scores above Savings Account. Liquid Funds have generated close to 8 – 8.25% annualised return over the past five years, which is just 4-6% in case of a Savings Account.

Benefits Of Liquid Funds

One of the biggest benefits of this type of Mutual Fund is that it comes with no lock-in period. Withdrawals are processed within 24 hours on a business day. However, there’s a cut-off time of 2 pm, which means if the redemption request is placed before 2 pm on a business day, the funds get credited in your bank account by 10am next day. Liquid Funds also don’t have an entry or exit loads.

As of December 2016, the average historical returns offered by Liquid Funds are as below :

Time Period

Returns

1 year 7.53%
3 year 8.25%
5 year 8.59%
10 year 7.81%

*Source: Value Research

How To Choose a Liquid Fund?

It is vital to choose the kind of Liquid fund you want to invest. Though the returns from these funds are more or less the same as they invest in similar underlying securities, a look at their past performances help. Factors such as fund size, track record of the fund house, and credit quality of underlying securities should be considered while shortlisting a liquid fund. It is advisable to invest only in high rated AAA Liquid Funds.

Based on their liquidity needs, investors can opt their plans such as growth plan, daily dividend plan, weekly dividend plan and monthly dividend plan. Retail investors can also get comparatively higher returns by investing in direct plans.

Taxation

When it comes to tax, Liquid Funds are treated differently from a savings bank account. Dividends received under liquid plans are subjected to dividend distribution tax at 28.84% in the hands of investors. However, the tax on capital gains would differ for short term and long term – if you go for a redemption before 3 years, then as per short-term capital gains, you will be taxed. These gains will be part of taxable income as per various slabs. If you redeem after 3 years, the gains would be considered as long-term capital gains, which is taxed at a rate of 20% with indexation benefit.

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