Bank Fixed deposits or FDs in short, have been a favorite investment option for many. Considered as a no-risk factor with a guaranteed return, individuals prefer FDs for the short term. Since interest rates on FDs have been declining gradually over the past few years, individuals are looking for options where they may put their money and maximize their wealth. This is where Mutual Funds enter the picture. In this article, we will be weighing Liquid Funds vs Fixed Deposits, so you make a knowledgeable selection.
Liquid funds, a popular kind of Mutual Funds Investments, offer much better returns than that of FDs. Mutual funds are managed by fund managers who make it a point to diversify the portfolio, maximize returns and reduce the risk. They invest in Best Debt, Money Market or Stocks. And choose funds that are consistently well-performing.
Liquid Funds vs Fixed Deposits
| S. no. | Factors | Liquid Funds | Fixed Deposits |
|---|---|---|---|
| 1. | Liquidity | High | Medium-High |
| 2. | Risk | Medium-High | Low |
| 3. | Returns | Not Guaranteed | Fixed |
| 4. | Taxation | For Long-term is favorable | As per the Income |
| 5. | Withdrawal | With Exit Load | With Penalty |
A detailed comparison of both the investment options will allow you to select the right one. Risk, Funds Availability, Returns, etc. are, generally the factors that may affect all investment decisions.
Let us understand how each of these elements is different for Liquid Mutual Funds vs Fixed Deposits:
Liquidity
Liquidity simply means how easily money can be taken out from an investment.
Investments in Liquid Funds are much more liquid, much more flexible in terms of the investment duration vs traditional Fixed Deposits.
Fixed deposits have a fixed tenure. It carries very low liquidity until the end of the tenure. An investment is FD is locked in for, generally 1-5 years, the duration of the investment period. This makes them less liquid. Pre-mature withdrawals, that is, redemption before this period, attracts some sort of extra charges in the form of penalty or fees. In other words, if you break an FD before its maturity, a penalty will be charged and you may have to forego a part of your earnings.
Once the tenure is over, the entire amount, principal and interest, may be credited to your savings or current account within an hour.
On the other hand, Mutual Funds returns may be redeemed at any point in time with an exit load. And the proceeds from liquid funds redemption would, generally, get credited to your bank account in 1-2 working days.
Returns
The Rate of interest in FDs is pre-specified. They do not change at any time during the investment period. More the duration, the better the rate of interest. For a lower duration, the interest rate is also low.
As opposed to this, the returns from Mutual funds are not based on a fixed rate of return. The return on investment (ROI) depends on the ups and downs in the market. Best Equity Mutual Funds are known to carry a higher level of risk whereas Debt Funds carry a lower risk.
Liquid Mutual Funds generally deliver similar returns when compared to FD.
The average returns delivered by Liquid Mutual Funds fall in the range of 6.6% to 6.7% p.a. And, currently, FDs are also giving returns around the same mark.
Potential Returns
As per the present situation of rising interest rates in the economy, the expected returns for all best mutual funds is set to increase from the present levels. Whether they are short-term funds or liquid funds.
Liquid funds invest in money market instruments. These have a very short maturity of up to 91 days.
In the event of rising interest rates, government securities, commercial papers, bonds, etc. shall also offer higher interest rates. And this is where the liquid funds invest.
Once the duration of these instruments, already been issued at lower rates gets over, liquid funds can buy new papers or other securities bearing higher interest rates. The case is not so with FDs.
In such situations, the returns of one-year investments in Liquid Funds can be equal to or even higher than the one-year returns offered by FD. According to some researches, the returns from Liquid Funds over the period of time could exceed the returns vs those offered presently by the Fixed Deposits.
However, keep in mind, this is a prospective scenario, which would only materialize if the interest rates continue their upward movement.
Funds Availability
An investment in Fixed Deposits needs to be made in a lump sum. Whereas Mutual Funds allow you more options. You can choose to invest via a systematic investment plan (SIP) and put a fixed amount regularly. This brings financial discipline and diversifies the risk of the portfolio. You, also, have the option to invest your Lump Sum in Mutual Funds. If you receive a huge sum and want to invest.
Taxation
One major factor due to which the general people invest is to save taxes. For a lot of us, the tax treatment is also one factor to be considered while weighing the investment options. In the case of Fixed Deposits, the tax is levied as per the current tax slab applicable to your income. The reason is that the interest income received from a bank FD is added to your total income and then taxed. Therefore, assuming that your income falls in the 30% tax bracket, any interest from your bank FD will get charged at 30% plus a surcharge.
Moreover, if the interest income earned from an FD is more than Rs.10,000 in a financial year, then the bank deducts a TDS or tax deducted at source at the rate of 10%.
Whereas, for Liquid Fund Taxation purposes, the dividend received is tax-free.
The impact of gain or loss on mutual fund depends on the type of fund. For equity mutual funds, the short-term capital gain is taxable. But the long-term gain is tax-free. For Debt Funds, the short-term capital gains are taxed according to the income slab of the investor and the long-term capital gain is taxed at 20% with indexation or 10% without indexation.
Long-term capital gains (LTCG) on liquid fund schemes which are held for more than 3 years are taxed at 20% after allowing for the benefit of indexation.
This indexation makes it possible for Liquid Fund investors to have a lower tax expense.
Therefore, in the case of Tax Saving investment in liquid funds, the effective tax rate is reduced because of indexation. This makes a significant difference in the net tax outgo for the investor.
Also read: Tax Saving Mutual Funds
Risk
Another important factor to be considered while investing is the risk associated with it. All Mutual Funds investments, whether Liquid or Equity, carry a certain amount a risk with them vs FDs, which are considered to be no-risk investments.
Liquid funds are subject to all kinds of risks associated with market investments. They may be fluctuating prices, interest rates, and other macro factors. All of it results in a fluctuating NAV. Even though, the fluctuation in the NAV of liquid funds is very little and doesn’t affect the investor in any notable manner.
Liquid funds are riskier, though only minutely vs the traditional bank Fixed Deposits on account of the credit risks.
Fixed Deposits are regarded as being almost risk-free. And are, therefore, preferred as a go-to investment option for risk-averse investors.
Conclusion
After analyzing the various aspects of both the investment options, it may be concluded that Liquid Funds fare better vs Fixed Deposits. We can understand that liquid funds have their advantages over FD in many very important criteria.
If you can take a slightly higher risk. And would prefer to invest for a long tenure, investing in mutual funds will give a higher return. They offer greater liquidity when compared to FDs. And no extra charge for pre-mature withdrawal.
Also, liquid funds come with no fixed lock-in period, unlike bank FD. Liquid funds also score better vs Fixed Deposits when the taxation is concerned.
Investors of liquid funds enjoy the indexation benefits, which reduced their total interest earned at the time of calculating taxes.
All in all, liquid funds are a very good option over FDs for those investors who are looking to invest their money for earning decent returns and maintain high liquidity.
For those who do not want to take any risk and are only looking for a pre-specified return, Fixed Deposits will be ideal.
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