What Are Liquid Funds?
As far as investing your money is concerned, choosing an investment avenue is a critical decision. While there are so many avenues you can choose from, two options remain popular and the most preferred by people. These are liquid funds and savings accounts. Liquid funds are short-term mutual funds investing in safe, liquid debt.
They are ideal for parking surplus funds, offering low risk and moderate returns. Savings accounts, on the other hand, are basic deposit accounts with modest interest, providing a safe place for everyday savings and emergency funds.
Both have advantages and disadvantages. The big question is: liquid funds vs savings accounts - which would you prefer? Or which one do you think is a better investment option? To choose the right one, you must understand the difference between the two, i.e., their advantages and disadvantages.
In this article, we will compare liquid funds vs savings accounts and determine which investment option is better for your portfolio.
A liquid fund is a type of Mutual Fund that invests primarily in money market instruments maturing within 91 days. Liquid funds offer higher liquidity levels, meaning you can easily convert your money to cash whenever you want. They are ideal for investors who have money and want to earn higher returns. They are also suitable for investors with a lower risk appetite who want to invest in short-term instruments.
What Are Savings Accounts?
Savings accounts are an essential financial tool used to store money and achieve financial goals. A savings account is a form of a deposit account offered by banks where you can bank your funds and earn nominal interest on your balance. Savings accounts are used preferably for short-term saving goals and emergency funds. Savings accounts typically offer lower interest rates when compared to other investment options like fixed deposits, mutual funds, or liquid funds.
Savings accounts are a safe investment option because the government provides insurance on deposits up to a certain amount. Also, savings accounts offer easy access to your money with the availability of an ATM card, online banking, and branch visits.
Most banks in India require a minimum balance in their savings account to avoid penalties or charges. The minimum balance varies from bank to bank. Some banks offer opening zero balance account online with limited requirements, making them accessible to low-income individuals.
Liquid Fund vs Savings Account
So, what’s the difference between liquid funds vs savings accounts? Well, liquid funds and savings accounts are different in more ways than one.
The primary difference between liquid funds and savings accounts lies in the returns they offer. Liquid Funds have higher returns than savings accounts though they come with a slightly higher risk factor. Liquid funds are subject to market fluctuations, and their performance depends on the performance of the underlying assets. Hence, the returns are not fixed and are market linked.
On the other hand, a savings account offers a fixed interest rate that varies from bank to bank. The returns from savings accounts are relatively low compared to liquid funds, but have more stability and are not dependent on market performance.
When comparing these two investment options, it is essential to consider factors such as risk, returns, liquidity, and taxes. Now let us look closer at liquid funds vs bank savings accounts based on these merits.
Returns
Savings Accounts are often perceived as the safest investment option. However, the returns they offer are relatively low. Most banks in India have interest rates ranging from 2.5% to 4% per annum on savings accounts. On the other hand, liquid funds are a considerably better alternative to savings accounts. They are well known to provide moderate returns ranging from 6% to 7% per annum. So if you’re looking for higher returns on your money, liquid funds may be a better option than a savings account.
Risk
Savings accounts are, to a large extent, considered to be the least risky investment option. In India, savings accounts are insured for up to Rs. 5 lakh by the DICGC (Deposit Insurance and Credit Guarantee Corporation). Also, savings accounts offer a fixed interest rate, and market performance has no effect on the returns.
As mentioned earlier, liquid funds are subject to market fluctuations. They are therefore considered more risky than savings accounts. While this is true, liquid funds have relatively lower risks when compared to other mutual fund schemes. These funds mainly invest in debt securities with a short-term maturity period. However, if you don't want to take risks, a savings account may be a better option.
Taxation
Savings accounts are subject to taxation per the Income Tax Act of 1961. If your total interest income from all accounts exceeds Rs. 10,000 in a financial year, you will pay tax according to your tax slab. Liquid funds are subject to taxation as per the capital gains tax rules. If you hold liquid funds for under three years, the gains will be summed to your taxable income and taxed according to your tax slab. If you take it for more, long-term capital gains will be taxed at a flat rate of 20% plus surcharge and cess. So, if you’re looking for a tax-efficient investment option, you may want to go with liquid funds as your ideal choice.
Liquidity
Savings accounts are very liquid, meaning you can easily withdraw your money whenever you want. Liquid Funds are still relatively liquid but may require a few days to process your withdrawal request. Additionally, you may incur penalties for early withdrawals. If liquidity is your top priority, a savings account may be a better option.
Conclusion
After analysing liquid funds vs savings accounts, it can be said that determining which one is better depends on one's financial goals and risk tolerance. Both liquid fund vs bank savings accounts have their advantages and disadvantages. While liquid funds offer higher returns and are tax efficient, they also come with higher risks.
Savings accounts have greater liquidity, safety, and guaranteed returns but may not be tax efficient. Ultimately, you should choose an investment option that aligns with your investment goals, risk appetite, and financial situation. If you require easy access to your money with a low-risk investment option, a savings account may be the right choice. However, if you don’t mind a bit of market risk and require higher returns, you should consider liquid funds.
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This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empanelled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees, and contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.
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