Liquid Funds vs. Savings Account – Overview, Returns, Risk

Most of us have surplus funds that we wish were better utilized. Two of the means by which these surplus funds can find their use is by investing in either liquid funds or keeping it in the savings bank account in a bank.

What is a Liquid Fund?

Liquid funds are debt mutual funds that require investments for short investment horizons (10 days to three months). The investment is made in money market instruments such as certificates of deposits, treasury bills, and commercial papers with a maturity period of 91 days and these are only invested in if they have a high credit rating. The main investment objective is the preservation of capital and high liquidity of funds.

What is a Savings Account?

A savings account is an interest-bearing deposit account that is held with a bank or financial institution. They offer a moderate rate of interest with an average of 3 to 6% per annum and depend on the Repo rate decided by the RBI. One of the biggest benefits of such accounts is that they are associated with safety and reliability. In other words, they can help you generate risk-free returns (however, the yield will not be very high). 

The interest earned on a savings account is tax free until Rs. 10,000  under Section 80TTA and the TDS threshold is placed at Rs. 40,000 as per law.  For senior citizens, up to Rs 50000 in interest on the savings account is exempt under Sec 80TTB.

Returns on a Liquid Fund v. Returns on Savings Account

Savings Bank Account	Liquid Funds
It generates risk free returns.	The returns generated are low risk. There is a risk associated with interest rate and credit.
The rate of return is a meagre 4%.	The rate of return is usually between 7 to 8%.

Benefits Associated with Liquid Funds and Savings Account

1. Liquid funds –

• There is no lock in period.
• Redemption can be done without any hassle and the money will be received within a day or two.
• Least interest rate risk as compared to other instruments.
• No minimum balance is required.

2. Savings Account –

• There is no risk involved.
• It can be redeemed immediately.
• There is no lock-in period.

Risks Associated with Liquid Funds and Savings Account

The risks associated with savings bank accounts are next to none. They are not subject to market or credit risks. Liquid funds, on the other hand, have a risk profile that’s similar to that of savings banks, though slightly higher. Note that depending on the market circumstances, the Net Asset Value of the fund might change.

Similarities Between Savings Bank Account and Liquid Fund

• Both the funds are easily accessible.
• They are both highly liquid funds.
• The money invested can be used for emergencies too.
• The principal is kept intact.
• Interest are not inflation-resistant.

Which is a Better Investment Option?

Before determining which of the two is a better investment option, it is prudent to look into the differences between the two first. They are as follows – 

Parameters	Liquid funds	Savings bank account
Minimum balance	There is no such requirement.	A minimum balance is to be kept in the bank account.
Tax implications	Short term capital gains tax is levied according to the income tax slab that the investor falls under if held for periods of up to 36 months When the holding period is over 36 months, long term capital gains tax is applicable with indexation benefit.	Tax is levied on the interest earned.
Involvement of the bank	There is no requirement to approach the bank to transact or get cash.	The money will be deposited to the bank account from which it is to be withdrawn.
Purpose	It is an ideal option for those who wish to get a higher return than savings account interest.	It is an option for those who wish to park their funds in the bank.
Liquidity	Cash is transferred to your bank account within one working day of placing the redemption request	Funds in savings bank accounts can be withdrawn at any time.

There is no predetermined answer as to which is the better of the two types of investment. Amidst the two, investing in liquid funds over savings accounts is often recommended as liquid funds are highly flexible and there is no penalty or exit load attached to them. 

Quite a number of liquid funds have a better interest rate than that savings accounts. These liquid funds are said to deliver nearly double the returns as compared to a traditional deposit in the savings account of most banks. Some asset management companies even offer ATM facilities to withdraw money. The only disadvantage of a liquid fund in comparison to a savings account is that it takes one to two working days for one to access these funds.

Frequently Asked Questions