Liquid funds vs Bank fixed deposits (FDs): Where you should invest?
Premium- Financial experts advise individuals with modest risk appetites to invest in debt products rather than equity
Financial experts advise individuals with modest risk appetites to invest in debt products rather than equity. Bank fixed deposits are the most popular type of debt investment among investors, but those with low-risk tolerance who want to outperform bank deposits should take a closer look at liquid funds. As the name implies, these are the most secure mutual funds since they invest in fixed-income securities with maturities of up to 91 days or 3 months, such as treasury bills, commercial paper, government securities, bonds and debentures. Consequently, these funds are perfect for individuals to park their hard-earned money in order to meet short-term financial objectives. However, in fixed deposits, one can invest from 7 days to 10 years, but the returns are only higher in the long term and in the short term one can expect similar returns to savings accounts. If investors had to choose between liquid funds and bank fixed deposits, where should they put their money in the short term?
Liquid Funds
Liquid funds, as we covered above, are short-term funds that invest in debt securities with maturities of up to 91 days. Let's use this as an example: If a business needs short-term funding and is willing to offer an interest rate in exchange for issuing bonds or debentures to the market, liquid funds will invest in these kinds of securities. One important thing to remember from this is that investments are not locked because liquid funds do not have a lock-in period and therefore do not have an exit load and investors can stay invested in liquid funds for the period they want to as the fund manager keeps investing in new debt securities after one matures after 3 months, hence you don't have to invest for a fixed term and can redeem your units whenever you want to, which makes these funds termed as a liquid.
The maximum single sector allocation for liquid funds is 25% generally, and they are only permitted to invest in listed debt instruments. Furthermore, at least 20% of the holdings in these funds comprise a net asset in a single group. Since a liquid fund solely invests in short-term securities, such as money market securities and cash, they do not experience major capital losses or gains as they invest in fixed instruments that have high credit ratings. Liquid assets frequently perform better than other bank fixed deposits in an environment with rising interest rates, due to the inverse relationship between bond price between and interest rates. Although liquid funds are not completely risk-free, they do carry a lower level of risk than other classes of debt funds because the underlying securities have a shorter maturity period. Risk-averse investors should be aware that if the credit ratings of the underlying securities change, it may cause the fund's NAV to be volatile. Liquid funds are subject to both short- and long-term capital gains taxes; as a result, capital gains are taxed when an investor redeems fund units for an amount more than what they paid for them.
Bank Fixed Deposits
The repo rate was increased by the Reserve Bank of India by 40 basis points in May, 50 basis points each in June and August, and now stands at 5.4%. Retail inflation, which is measured by the consumer price index (CPI), settled at 7% in August. The RBI is anticipated to hike the key rate for the fourth consecutive time on September 30 in an effort to control persistent inflation. Nearly all banks, including private, public, and small finance banks, have increased their fixed deposit interest rates as a result of the increase in the repo rate in an effort to fend off the demand for credit. In the current environment, one may now anticipate interest rates ranging from 6 to 7% for bank fixed deposits, and if it is up to small finance banks, interest rates are now about 8%.
However, when contrasting liquid investments with bank fixed deposits, it is important to keep in mind that in bank fixed deposits, your investments are locked in for the chosen tenure, making early withdrawals only possible with a penalty. This lowers the interest income and also makes fixed deposits unsuitable for emergencies. When compared to bank fixed deposits, liquid funds provide simple liquid alternatives, allowing for more flexible withdrawals and higher returns. On the other hand, investors get dividends and capital gains from liquid funds, however, investors should be aware that dividend income and interest income from bank fixed deposits are subject to TDS deduction. According to Section 194, a TDS of 10% is deducted if the total dividend paid to shareholders during a fiscal year exceeds Rs. 5,000. Whereas, the TDS rate is 10% under the Income Tax Act, 1961 if the interest income generated on bank fixed deposits exceeds ₹40,000 in a financial year.
Where should you invest?
By asking about where to invest in bank deposits or liquid funds, Mr. Sandeep Bagla, CEO of TRUST MF said “Liquid Funds & bank FDs can both be used to park short-term surpluses and earn moderate returns with low risk. While securities in a Liquid Fund are subject to daily mark to market, FDs provide returns without volatility."
“There is a graded exit load in liquid funds for the first 6 days, which becomes zero from the 7th day onwards. In the case of FDs, there is a penalty for early withdrawal through the term of the deposit. In case interest rates soften, liquid funds can deliver returns higher than the portfolio yield, and vice versa. FD rate of return stays the same throughout its tenure." he further added.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.
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