5 Reasons Why Liquid Funds are attractive alternatives to Saving Deposits

Do you have your large sums idling in your saving accounts? How many of you wouldn't like to see your money grow faster than that in saving bank account while having less exposure to market risk? The answer is obvious. We all would. But, the question is how? The answer is simple: By investing into Liquid Funds.

Let’s have a quick review of the features of Saving Accounts before discussing Liquid Funds in detail.

Saving accounts are one of the most popular deposit accounts for individuals in India. In Saving Accounts, the depositor is normally issued cheque books and the customer is allowed the flexibility of deposits of any amount and withdrawal of funds from the account at any time. Although, most of the banks have rules for the maximum number of withdrawals in a period and the maximum amount of withdrawal, yet no bank strictly enforces these owing to competition in the banking circles.

Interest on Saving Accounts

Till 24/10/2011, the interest on Saving Fund accounts was regulated by RBI and it was 4.00% p.a. on daily balance basis. However, w.e.f 25th October, 2011, RBI has deregulated SF interest rates and banks are now free to decide the same within certain conditions imposed by RBI. However, it varies from 4-7 % p.a.

What is a liquid fund?

A liquid fund is a debt mutual fund that invests in very short-term instruments like commercial papers, treasury bills, certificates of deposit, and so on. Liquid funds generally invest in instruments that have a very high credit rating.

Advantages of Liquid funds over Saving Accounts:

1. Returns –

Amidst high inflation, for short duration Liquid Funds are among the best investment instruments available to the individual. During high inflationary period, the RBI typically keeps interest rates high and tightens liquidity, helping liquid funds to earn good returns.

Liquid Fund Returns	Liquid funds returns in %
Time Horizon	1 month	3 month	6 month	1 year
Average Returns	0.81	2.19	4.47	9.01
Highest Returns	0.94	2.4	4.9	9.98

Source: Value Search (Returns are as on April 11, 2014)

Liquid funds have the lowest interest rate risk among debt funds as mutual fund houses generally invest in fixed income securities with short maturity.

2. No lock in period-

Liquid funds have no lock in period and money can be withdrawn with 24 hours on request. The cut- off time on withdrawal is generally 2 P.M. If someone requests for withdrawal by 2 P.M, it is processed by 10 A.M the very next day. Liquid funds have no entry and exit loads.

3. Risk-

A liquid fund has very low risk. The maturity of the instrument can go up to 91 days. But portfolios of most liquid funds have average maturities well below that; even six or eight days sometimes. Since the instruments have very short tenures, they are not traded in the market, and instead held-to-maturity by the fund. This removes mark-to-market losses on the instruments and eliminates volatility. Unlike liquid funds, other debt funds have securities with longer maturities and so are more influenced by interest rate changes and market movement.

4. Plans as per your needs-

Liquid funds are available in different plans like growth plans, daily dividend plan, weekly dividend plans and monthly dividend plans. Growth plans don't declare any dividend, and appreciation of fund is reflected in higher unit value. Investors can the option to select their plan as per their convenience and liquidity needs.

5. Taxation-

Dividends received under Liquid plans are not taxed at the hands of resident individual investors but fund houses pay dividend distribution tax @28.325 per cent (including surcharge and cess).

Individual investors who books gains before a year on their investment in liquid funds are taxed at the same rate as per their income slabs. Interest earned from savings accounts are also taxed at this same rate.

So, it is a wise decision to park your large sums idling in your saving account into liquid funds and see your money grow with your baby and be happy. I would suggest to invest 60% of your large sums idling in your saving account into liquid funds and 40% into saving accounts to meet any unexpected requirements. The investor can, however, choose the right proportions as per their needs.

- Manish Kumar | T A Pai Management Institute, Manipal