Liquid Funds or Savings Bank Accounts – Which is better?

 

Keeping money in your savings bank account is the easiest way to invest your money but may not be the smartest. Money lying in the Savings Bank Account does not even beat the inflation.

We never check the impact of inflation and taxation on our investment.

One of the main enemies of saving money is inflation.

Inflation and Taxation are two silent killers on your money or investment. Yes, Think about it.

Just check last 2 years inflation rate, In 2014, Inflation rate was 6.37% and in 2015, Inflation rate was 4.97%.

It may be negative inflation for some years or very high inflation for some years. In India, Last 59 years (1958-2016) Average Inflation Rate is 7.50%.  Just imagine the impact of inflation!

Inflation hurts your buying power. It means you have to pay more for the same goods and services.

[blockquote style=”1″]“Twenty years ago, when I had a thick mop of hair, I used to pay Rs. 25 for a haircut. Ten years ago, after my hair started thinning, I was paying Rs. 50 for a haircut. And now, when I have virtually no hair left, I am paying Rs. 150 for a haircut.” – D. Subbarao, RBI Governor in July 2012[/blockquote]

Taxes are a day-to-day reality for just about every person in India. The Central Govt. taxes everything that you earn, unless you have deductions or other legal tax exemptions.

Don’t waste your time and money, and don’t let a tax lien be a silent killer in your portfolio.

With the increase in the popularity of Financial Planning concept and its consumers, the awareness about mutual fund products has also enlarged. Specially, the debt mutual funds schemes have emerged as an alternative to the short term saving products offered by banks.

Liquid funds are no brainier for companies as they earn no interest in their current accounts. Individuals use to keep the surplus money either in saving account or in Fixed Deposits; however liquid funds have evolved as a strong contender to the saving bank account and to some extent also to the fixed deposits.

But with the recent changes in the tax structure of Debt Mutual Funds, are liquid fund scheme still better alternative to bank accounts?

Before we examine into it, let’s first understand more about Liquid Funds.

Liquid Mutual Funds 

Liquid funds are open ended debt mutual fund schemes which invest into short term money market instruments without any exit load. The focus of Liquid fund is to generate return by maintaining highest liquidity with minimum risk in short term.

Liquid funds are a type of debt mutual funds which primarily invest in money market instruments like Certificate of Deposits (CDs), Commercial Papers (CPs), Term Deposits and Treasury Bills, where the maturity of debt papers is upto 91 days.

Features of Liquid Funds

# Invest in short-term government securities and certificate of deposits, making them reasonably secure

# Provide flexibility to invest or withdraw any time without any exit load or penalty.

# Some mutual fund houses even offer an ATM card to withdraw the funds

# Tax efficient schemes

# Have historically provided higher returns than savings bank interest rate

How liquid funds are different from saving account?

Saving accounts are the most popular instrument in which people keep their savings for day to day needs or emergency funding or short term parking. These are maintained by banks and post offices where people have the flexibility to deposit and withdraw money at any time.

India’s largest lender State Bank of India (SBI) on 31st July 2017 cut interest rates on savings bank deposits by 0.5 per cent.

Now, for saving deposits balance up to Rs 1 crore, SBI will offer a rate of 3.5 per cent as compared to 4 percent earlier.

Other Banks may decrease their saving bank interest rate in future.

The savings bank account that gives very high liquidity but very low rate of interest, even less than the rate of inflation.

The interest on saving account varies from 3.5% to 4% and the interest paid is tax free upto the limit of Rs.10,000 per year. Anything over and above the limit is added into the annual income and is taxed as per the respective slab.

Liquid funds as explained above are managed by mutual fund companies. The liquid fund carries the minimum risk as the instruments are of very short term and thus it eliminates the volatility risk.

Other debt funds have instruments with longer maturity which carries interest rate volatility risk. There is no lock in period for liquid funds and on withdrawal request the funds are transferred within 24 hours. Also one of the Mutual Fund Companies offers the facility of ATM linked with fund, so at any time investor can withdraw the funds & few other provide SMS facility to transact.

Liquid funds are available with different investment options like Daily Dividend, Weekly/Monthly Dividend and Growth option.

Tax implication on Liquid Funds

There is a different tax impact that will also be seen when one considers the savings bank account and the liquid fund. The interest that is earned on the savings bank account is taxable in the hands of the investor but there is a deduction that is also available. The first Rs 10,000 of income from interest on savings bank is not taxed and the taxation starts after the income crosses this level. This provides some benefit for the investor.

Liquid funds have been earning in the range of 8-9% per year for the last few years. Even though returns in the last year have come down to around 7.5%, they are continuing to earn marginally higher than the deposits offered by most banks.

Unlike bank deposits upon which tax has to be paid annually on all interest earnings, mutual funds get taxed only when you liquidate them. Liquid funds follow the taxation structure of debt mutual funds. There are two types of taxes, namely Short-Term Capital Gain (STCG) tax and Long-Term Capital Gain (LTCG) tax associated with it.

‘Short term’ in case of debt funds applies to any redemption carried out in less than three years. In case of equities, ‘short term’ stands for a period less than one year. Short-term capital gains are added to your income and taxed as per the tax slab.

‘Long term’ stands for a period more than three years in case of debt funds. If an investor redeems after three years of investment, he is liable to pay the LTCG tax of 20% on capital gains after indexation. The indexation method helps you determine the inflation-adjusted purchase price for your investment, thus significantly reducing your tax incidence.

One should always look at post tax returns for any investments. Liquid fund investments are tax efficient as compare to bank Fixed Deposit and Savings Bank account.

Liquid Funds– Ideal for parking of funds for the short term. Given recent decreasing of savings bank interest rate, these funds have become more attractive.

Prudent investing and financial discipline are vital ingredients for long-term financial well being.

[blockquote style=”1″]“Money is a terrible master but an excellent servant.” – P. T. Barnum[/blockquote]

Disclaimer: Kindly note that the above illustration is based on past performance. Mutual fund investments are subject to market risks. read all scheme related documents  carefully. Past performance may or may not be repeated in future. The products do not offer any guaranteed or assured returns whatsoever.

 

I am a CERTIFIED FINANCIAL PLANNERCM. For the moment, I have shared my experience growing up with you because it had a tremendous impact on how I do what I do.

If you have a question about your own financial situation please connect with me.  I’d be delighted to try to be of service.

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