Liquid Mutual Funds are a better alternative to bank deposits

What are Liquid Mutual Funds?

Liquid Mutual Funds are a type of Debt Mutual Fund, that loans money against very short term high quality bonds issued by RBI, State Governments, Other Banks, and even publicly listed corporates.

Indian TV audiences aren’t new to #MutualFundSahiHai campaign one of which ends with a well-wishing dude telling his friend how he can keep money in mutual funds for shorter time duration, like 3-6 months. That’s what a Liquid Mutual Fund is suited for.

Bank deposits are liable to income tax on interest earned

For a Bank FD or a savings bank account credit interest earned is liable to taxes (see line 26AS in the ITR form). The bank will deduct TDS on your behalf and you’re liable to pay tax as per slab rate (20% and 30%) and settle the difference with IT department as Self-Assessment Tax.

How does it feel to pay taxes from your own pocket, on paper gains, while the fixed deposit remains intact?

There is an alternative – Liquid Mutual Funds.

How are Liquid Mutual Funds better?

1/ Post-tax annualized returns are higher:

Returns are usually in-line with bank FDs, but since there’s no tax until you redeem, post-tax returns are hands down better than most bank deposits.

Let’s run some numbers. We take category average of Liquid Funds in last 1-Year, which at the time of writing this, stands at 6.95%.  And, let’s assume you’re in 30% tax bracket had an FD of 10L created 1 Year ago, and your bank offered you 7% FD.

For your Bank FD you effectively got a post-tax return of 4.82%. The tax liabiliyt (TDS and Self-assessment Tax in the table above) affects compounding. The amount available in deposit for compounding is less than what’s available in the liquid fund. And as years go by, the gap widens more.

With liquid funds, only capital gains tax apply and that too at the time of redemption. If you withdraw your holdings after 3 years of holding period, you also get indexation benefit to reduce your tax liabilities.

2/ There is no exit penalty:

True to its name, it’s liquid, you can add any amount or withdraw any amount, without any exit penalty, unlike any Bank FD which has an early redemption fee. Some fund houses even offer instant redemption up to 50k or 90% of your total investment in the fund.

Top 5 Liquid Mutual Funds by 3Y returns are:

INDIABULLS LIQUID GROWTH DIRECT PLAN

ESSEL LIQUID GROWTH DIRECT PLAN

BARODA PIONEER LIQUID B GROWTH DIRECT PLAN

JM LIQUID GROWTH DIRECT PLAN

PRINCIPAL CASH MANAGEMENT GROWTH DIRECT PLAN

The above benefits make Liquid Mutual Funds a better alternate to bank deposits to park short term money or emergency funds.

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This article was initially published by CNBCTV18 in the Personal Finance section.