Confused between Liquid Funds and Fixed Deposits?
Investing is like choosing the perfect pair of shoes- it depends on your purpose and comfort. For investors looking to grow their money safely, Liquid Funds and Fixed Deposits (FDs) can be two favourite options. But which one should you choose?
What are Liquid Funds?
Liquid Funds are a type of mutual fund that invests in short-term and highly rated money market instruments like treasury bills, corporate bonds, and commercial papers. These instruments usually mature within 91 days.
Example
Suppose you got ₹50,000 from a recent bonus. Instead of letting it sit idle in your savings account, investing in Liquid Funds can generate better returns with easy access in case of emergencies.
Benefits of Liquid Funds
1. Better Returns Than Savings Accounts
Liquid Funds invest in short-term, high-rated money market instruments such as treasury bills and corporate bonds. These investments typically give returns that are higher than savings account interest rates. However, since returns are market-linked, they are not guaranteed.
If you invest ₹50,000 in a savings account earning 3% annually, your return after a year would be ₹1,500. On the other hand, investing the same amount in Liquid Funds may yield 5%, which could give you ₹2,500.
2. High Liquidity with a Minimal Lock-in Period
Liquid Funds allow you to withdraw your money anytime. Withdrawals are credited to your bank account within 24 hours. An exit load (meaning a small penalty) is only applicable if funds are redeemed within 7 days.
Imagine you need cash for an unexpected car repair. With Liquid Funds, you can redeem your investment and have the amount available by the next business day without any penalty.
3. Tax Efficiency for Long-Term Holders
Liquid Funds held for more than three years qualify for Long-Term Capital Gains (LTCG) tax at 20%. This reduces the tax burden compared to investments taxed at the individual’s income slab rates (such as the 30% income tax slab rate).
4. Low Entry Barrier
Liquid Funds have a low minimum investment threshold, often starting at ₹500, making them accessible to new investors or anyone with limited funds.
If you are a student or young professional, you can start a liquid fund with a small amount and build your investment over time.
5. Less Affected by Interest Rate Fluctuations
Liquid Funds invest in instruments that mature within 91 days, which reduces their sensitivity to changes in interest rates, making them more stable than longer-duration mutual funds that have lock-in periods.
What Are Fixed Deposits?
Fixed Deposits (FDs) are a type of secure savings instrument where you deposit a lump sum with a bank or Non-Banking Financial Company (NBFC) for a fixed period, earning a guaranteed interest rate. FDs are ideal if you are someone who is looking for risk-free returns.
Example
Imagine you are saving for a big purchase two years from now. An FD ensures your money grows steadily without any risk.
Benefits of Fixed Deposits
1. Guaranteed Returns
FDs offer a fixed interest rate for the chosen tenure, unaffected by market fluctuations. This makes them ideal for risk-averse investors seeking predictable income.
If you invest ₹1,00,000 in an FD offering 6% interest annually, you will know in advance that your return after a year will be ₹6,000, irrespective of market conditions.
2. Flexible Tenure Options
FDs provide the flexibility to choose tenure ranging from 7 days to 10 years, depending on your financial needs. This makes them suitable for both short-term and long-term goals.
Take for example, a retiree who is looking for a steady income may go for a 5-year FD, while someone saving for a vacation next year might choose a 1-year FD.
3. Safety and Security
FDs are considered one of the safest investment options as they are regulated by the Reserve Bank of India (RBI). Additionally, investments in bank FDs are insured up to ₹5 lakh under the Deposit Insurance and Credit Guarantee Corporation (DICGC).
4. Tax-Saving Options
Tax-saving FDs allow deductions up to ₹1.5 lakh under Section 80C of the Income Tax Act under the old tax regime. However, they come with a 5-year lock-in period.
If your annual taxable income is ₹7 lakh, investing ₹1.5 lakh in a tax-saving FD can reduce your taxable income to ₹5.5 lakh.
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5. Option for Periodic Interest Payments
FDs provide the choice to receive interest payouts periodically (monthly, quarterly, etc.) or at the end of the tenure. This feature is especially beneficial for retirees who need a regular source of income.
A retired individual who has invested around ₹10 lakh in an FD (assuming 7% annual interest) can opt for monthly payouts of approximately ₹5,833 to cover living expenses.
Differences Between Liquid Funds and Fixed Deposits
| Parameter | Liquid Funds | Fixed Deposits |
|---|---|---|
| Risk | Medium (market-linked) | Low (guaranteed) |
| Returns | Higher, but not guaranteed | Lower, but fixed |
| Liquidity | Highly liquid; no penalties after 7 days | Penalty for premature withdrawal |
| Tenure | 7 to 91 days | 7 days to 10 years |
| Taxation | LTCG (20%) | Taxed as "Income from Other Sources" |
| Minimum Investment | As low as ₹500 | Usually higher; varies by bank |
Which Is Better for You?
Case 1: Short-Term Goals
Liquid Funds are ideal if you need flexibility and higher returns for a shorter duration, like managing cash flow or emergency funds. If you have ₹25,000 to park temporarily before using it for rent payments, Liquid Funds offer better returns and quicker access compared to an FD.
Case 2: Long-Term Goals
FDs work best for fixed timelines and guaranteed returns, making them suitable for retirement savings or future expenses. Take for instance, a parent saving ₹5 lakh for a child’s higher education five years down the line who might prefer FDs for guaranteed returns.
Wrapping Up
Choosing between Liquid Funds and Fixed Deposits boils down to your financial goals and the degree of risk that you can take. If you are seeking better returns and high liquidity, Liquid Funds are a great choice. On the other hand, if guaranteed safety and fixed returns are your priorities, Fixed Deposits are the way to go.
FAQs
What are Liquid Funds?
Liquid Funds are mutual funds investing in short-term money market instruments with high credit ratings, that offer better returns and liquidity than savings accounts.
Are Liquid Funds riskier than FDs?
Yes, Liquid Funds carry market-related risks, while FDs are virtually risk-free.
Which offers better returns, Liquid Funds or FDs?
Liquid Funds usually offer higher returns, though not guaranteed. FDs have fixed returns.
How quickly can I access my money in Liquid Funds?
You can redeem your funds within 24 hours, without any exit load after 7 days.
Do FDs have a lock-in period?
Regular FDs can be withdrawn early with penalties. But, tax-saving FDs have a 5-year lock-in.
Are Liquid Funds tax-efficient?
Yes, if held for over 3 years, they qualify for LTCG tax benefits, where your capital gains are tax-exempt up to ₹1.25 lakh.
Can I use Liquid Funds as an emergency fund?
Liquid Funds are perfect for short-term emergencies due to their high liquidity.
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