Savings Account vs. Liquid Funds

Let’s understand Savings Account vs. Liquid Funds

In this article, we will be comparing savings bank account with liquid funds. Our grandparents and earlier generations use to invest regularly in traditional savings instruments such as bank FDs, traditional life insurance plans, gold, and real estate.

The investment avenues have broadened largely in the past three decades in India. Today, you can spread your money across many asset classes such as Debt funds, ULIPs, Equity Funds, Gold ETFs. These have become highly fruitful investment options for investors from a long-term perspective. Moreover, these options help investors adopt an effective diversification strategy for optimizing their hard-earned savings.

In this article, we will focus on Debt Funds as an effective option by comparing it with the traditional savings account. A savings account is a deposit account offered by banks, financial institutions, and post office. A savings account provides you with security of the principal amount while paying you quarterly and annual interest. Some banks require you to maintain a minimum balance in your savings account. Liquid funds are a type of Debt Mutual Funds, which invest in instruments such as commercial paper, treasury bills, and certificate of deposit. The maturity date of these instruments is a small period, which is generally 1-90 days. These funds are available to investors in two options – growth and dividend.

Risks

The risk in case of savings account is minimal since the principal is secured. The risk is minimal in case of liquid funds as well. The kind of instruments that these funds invest in have a very short maturity periods. Thus, they are not traded on the markets and are not affected as much by market fluctuations or interest rate changes. These investments are held by the fund houses until maturity. Moreover, Debt Funds generally invest in instruments with high credit rating from top ratings companies such as Crisil and ICRA. Thus, these investments are highly safe. A good question that you might get in your mind is if the debt instruments in which debt funds invest are not traded on the market, how does the NAV change? The NAV changes based on the interest accrued on the instruments that the debt funds have invested in.

Returns

Savings account normally offer around 4% annual interest. Some banks may offer slightly higher rates but may ask you to deposit higher amounts. However, Debt Funds have provided investors with annual returns of around 8% in the past few years with the good performing funds providing much higher returns. In case the interest earned by a savings account is more than Rs. 10,000/-, the amount is added directly to your gross total income (GTI) and taxed according to the respective tax slab. Thus, if your account earns you 4% interest p.a and you fall in the 10% tax bracket, you would ultimately earn net returns of 3.6%. If you are in the 20% tax bracket, net returns would be 3.2%, with the net returns dropping further to 2.8% if you fall in the 30% tax bracket.

In case of liquid funds, if you redeem your investments within 36 months, the amount would be added directly to your GTI and taxed as per your tax slab. Since the average returns provided by Debt Funds have been 8%, the post tax returns are also higher. If you fall in the 10%, 20%, or 30% slab your net returns would be 7.2%, 6.4%, and 5.6% respectively. This is much higher than the storing your money in a traditional savings account. Liquid funds are generally used for making short-term investments. However, if you hold on to your investments for more than 36 months, your investment will be taxed at a flat rate of 20% irrespective of your tax slab but after indexation. In case you have invested in Dividend Funds, the fund pays a dividend distribution tax on the amount that is given to the investor, which is the dividend amount. The dividend is tax-free in your hands.

Utility

Savings account should always be used as a reserve for your monthly expenses that include online funds transfer, shopping, and bill payments. That said, when there is a hefty sum lying idle in your savings account, you must invest that into Liquid Funds/Debt Funds. You could use debt funds for parking your emergency funds while gaining reasonably good interest. Moreover, in case you have sudden inflows and you have not yet decided on where you want to invest it, the best thing you can do is to park that into Debt Funds until you make up your mind on that inflow. This will allow the money to grow better and bigger.

Therefore, based on the nature of product, risks, post-tax returns, and utility, Liquid/Debt Funds become much more lucrative investment options than savings bank account for investors owing to higher and secure returns. To know more about Liquid Funds/Debt Funds or other Mutual Fund investments, write us at investmentz@acm.co.in or give a missed call at 08010968308

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

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