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Liquid funds are good alternatives to savings accounts

Aasif Hirani

Why do people park their money in a savings account? The answer would be people park their money in a savings account for short term where they have extra cash lying around and don t want to lock it in any investment. Most people pay little attention to the interest earned in savings account. Reserve Bank of India in 2011 brought changes and deregulated interest rate on saving deposits. Before that, every bank would offer 4% per annum but now banks can offer interest whatever they deemed fit. Some banks do offer higher interest to entice people to park their extra money but ask for a higher minimum deposit.

Spare cash in liquid funds
Have we ever thought how much spare cash we park in these low yielding saving accounts? It might be higher than we have thought. On the other hand, liquid funds help us in earning higher rates. So what is liquid fund? Liquid fund is a category of mutual fund which invests primarily in money market instruments like treasury bills, commercial paper, term deposits and certificate of deposits. Since one can redeem their investment anytime, low maturity period of all these money market instruments helps a fund manager in meeting redemption demand from investors.

There is no fixed amount on how much money one should park in a savings account, it should be one to two month s worth of expenses. The reason we park our fund in saving account is one, we know is either emergency fund or we will use it in future. The amount can be greater if we are expecting any near term expense other than our regular expense.

The interest amount on saving bank account is calculated on the daily basis in your account but the total interest is credit to your account only quarterly. There is a deduction of up to Rs 10,000 on interests earned from all your saving bank account in a financial year. So if you are keeping few month s expenses then the amount will generally be tax free unless your expense is really higher or you are keeping money in saving accounts as you have no other alternative to park your money.

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Dividends and interests
Dividends received under liquid plans are not taxed and individual investors who book gains before a year on their investment in liquid funds are taxed at the same rate as per their income slabs. Remember any interest earned above Rs 10,000 in savings account is also taxed at the same rate as per their income slabs.
The goal of putting your money in liquid funds is that they provide a good alternative to savings account. One should remember that unlike saving account, the returns of liquid fund are not guaranteed. They fluctuate, not as much but still they are low risk product and not zero risk product. So users should keep this in mind and not blindly put their emergency fund in liquid funds.

As the name suggest, liquid funds are fairly liquid. One would get their money in T+1 day. It should be categorized under emergency fund and park in savings account where we can withdraw today itself. But if we want it tomorrow and not any emergency, then we can easily get it from liquid fund.

It does make sense to park some of your money in savings account for immediate liquidity (emergency). So what we recommend is keep some part of your emergency or one month expense in saving account and rest in liquid fund. The factors that should one keep in mind is size of the fund, credit quality of underlying securities and track record of the fund house.

(The writer is director, Tradebulls Securities)