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Liquid Fund VS Savings Account – Which is Better?

Liquid Fund VS Savings Account – Which is Better?

With the increase in the popularity of Financial Planning and its users, the awareness about mutual fund products has also increased. 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 a/c 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 delve into it, let’s first understand more about Liquid Funds.

Liquid Mutual Fund VS Saving Bank Account

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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.

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 short term parking. These are maintained by banks and post office where people have the flexibility to deposit and withdraw money at any time. The interest on saving account varies from 4% to 7% 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:-

In his first budget on 10thJuly 2014, the newly appointed Finance Minister has made some changes into tax structure of Debt Mutual Funds Schemes. Now the LTCG on debt fund is 20% with indexation and the 10% without indexation option is withdrawn. He has also increased the minimum investment period for being considered long term from 12 months to 36 month. This was done to avoid the arbitrage opportunity available to debt fund investors over bank FD’s.

Also, under the dividend option the government has given the new formula to calculate the effective rate of Dividend Distribution Tax due to which now investors will pay 6.255% more tax. (Individual resident & NRI (tax on distributed income) = 25% + 12% surcharge + 3& cess = 28.84% – for Domestic Companies its 34.608%)

Under the growth option the investor is charged as per holding period (i.e. LTCG and STCG).

Liquid fund long term short term

LTCG: Long Term Capital Gain,    STCG: Short Term Capital Gain.

Under Dividend option the mutual fund company is charged with Dividend Distribution Tax (individual) as per below table:-

Liquid Fund Dividend distribution Tax

Is it still better to keep money in Liquid Funds than bank account?

Nobody will park their money in liquid funds for 3 years so in that scenario short term capital gain or dividend distribution tax will be applied to investor. The liquid fund has generated better returns than bank account in the past and hence it has emerged as better alternative. However, with the recent changes in the taxation policy the investors will pay more tax on the returns generated. Let us understand this with the help of the below table which shows the interest earned on the investment of Rs.5,00,000 each in liquid fund and saving account for two different person who comes under 20% and 30% slab respectively. (We are assuming that investor already consumed Rs 10000 tax benefit on saving bank interest – so a Rs1.5 lakh average balance in saving bank account generating 6%)

liquid plus fund taxation

*Assuming person has invested Rs.5,00,000 for 1 year, who falls under the tax bracket of 20%.

Ultra Short Term Fund Taxation

*Assuming person has invested Rs.5,00,000 for 1 year, who falls under the tax bracket of 30%.

8% returns from liquid funds are on higher side but hardly any bank is giving 6% interest on savings account 🙂 If your bank is paying only 4% – difference will be huge.

Are you keeping too much in Savings Account?

It is clear from the above tables that investment into liquid fund has generated better post tax return than of saving account even after the recent tax changes. However, while investing into liquid funds, please note that if you fall under 20% or 30% tax bracket, you may have to select the suitable option i.e Dividend or Growth, as the investor falling under 20% tax bracket will earn more under growth option and investor falling under 30% will earn more under dividend option. So, the idea of keeping the emergency fund or surplus money into liquid funds is worth exploring as it offers the combination of safety, liquidity and better returns. (you should also compare returns/flexibility of ‘sweep in’ accounts with Liquid Funds)

Rolling Returns of Liquid & Liquid Plus (ultra short term) Funds

Liquid Mutual Fund Returns

*Ultra short term funds have bit higher tenure & mark to market component.

Will you still keep the lumpsum amount in your saving account or will try and explore the benefits of liquid funds?

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{ 16 comments… add one }

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  • rajanikant v gajjar April 20, 2015, 7:11 pm

    your articles are not very lengthy,but still i would request to do more PRECIS WRITING-MORE CONDENSATION,because in today’s times your article is in competition with so many other emails for attention.Once it is set that emails from this sender does not take lot of time & they are really value for time spent,they will get more attention.
    I am really sorry if this is unwelcome comment,but I have shared reader’s problem with you.

    Reply
  • Ritu Vinay Kohli April 21, 2015, 11:51 am

    Hi,
    Greetings for the Day!
    Thanks a lot for all such wounderful knowledge sharing as being almost new kid on block, must be a great learning era starting.
    Really helpful n useful sharing.
    Warm Rgds,

    Reply
  • Dilip Rane April 21, 2015, 12:04 pm

    How about sweep in @9% interest rate?

    Reply
    • Vikas Agarwal April 22, 2015, 3:40 pm

      Dear Dilip,
      If you are getting 9% is sweep in – that’s awesome & you should stick with it.

      Reply
  • Abhishek Deep April 21, 2015, 7:44 pm

    Looking at the returns, is it not profitable if money is invested through FD or RD?

    Reply
  • shrikant April 21, 2015, 10:18 pm

    Dear Sir,
    Pl illustrate the PPF V/s Dynamic bond funds & other debt funds considering the tax bracket @ 10%/20% &30% with ref to above example of Rs. 500000/- for the better understanding of the investors.
    shrikant

    Reply
  • dayanand nalawade April 21, 2015, 11:31 pm

    very good articles….

    Reply
  • sankar April 22, 2015, 2:12 pm

    Nicely analysed article ; may kindly name a few worthy Liquid Funds for consideration. Has one got to open a DEMAT A/C as well ?

    Reply
  • sankar April 22, 2015, 2:27 pm

    May please write a separate article ,with proper illustrations , on INDEXATION.

    Reply
    • Vikas Agarwal April 22, 2015, 3:43 pm

      Dear Sankar,
      Demat is not required to invest in MF. Indexation will only apply if someone will keep this money in liquid funds for more than 3 years – liquid funds are wrong product for 3 year horizon.

      Reply
  • Anil Kumar Kapila April 23, 2015, 4:46 pm

    Right now I am not investing in liquid funds and prefer fixed deposits with mod facility.I can consider liquid funds if more fund houses provide ATM/Debit card facility.

    Reply
  • Abha Agarwal April 23, 2015, 5:32 pm

    The article is very good and informative but can I recommend this to my mother who is 72 years old , lives alone and puts most of her money in the saving bank due to ease of withdrawal, mutual fund offices are quite far from home, location of bank nearness to home and does not know mcuh about computer where she can redeem/switch it online? If yes in which funds can I ask her to invest?

    Reply
    • Anil Kumar Kapila May 19, 2015, 4:09 pm

      I think an elderly person who does not know much about mutual funds should stick to savings account in a bank close to home. Although most banks also deal in mutual funds I would not like to invest in mutual funds through banks unless you know somebody in the bank who can be trusted. So far I have not met any person in a bank whom I can trust for investing in mutual funds.

      Reply
  • Vinay Maithani July 20, 2015, 12:00 am

    Does it make sense for NRI’s (with no taxable income in India) also to park their emergency corpus (a portion of it atleast) in Liquid Funds ?

    Reply
  • kalpesh barot January 11, 2016, 7:22 pm

    If i got rs. 20000 short term c gain in liquid fund, what will be my tax liability?
    My salary income is 3.5 lac & my 80c investment is 1.5 lac

    Reply