A Liquid Fund Vs a Fixed Deposit: Which Is A Better Option?
Traditional investors still have faith in investments like fixed deposits. These are the oldest and most relied upon forms of investment, and have fans even today. Offering both reliability and assured returns, fixed deposits have been among some of the only ways to grow wealth in the past. Before the advent of stocks and mutual funds, which have gained strong momentum now, fixed deposits were much sought-after investment channels. The steady returns and tax benefits were a draw for many folks.
With the additional benefits of fixed deposits, investments are low in risk, and risk plays an important role while deciding investment instruments and products. There is also the nature of high liquidity in fixed deposits. However, as years have gone by, new and distinct kinds of funds have been created to specifically match the needs of individual inventors, especially for inventors who favour fixed deposits. Among these, liquid funds have a risk profile that closely resembles that of a fixed deposit. This is the reason why several investors compare these funds to FDs (fixed deposits) before allocating funds for investment. Once you have narrowed down your choice to either a fixed deposit or liquid fund investment, it’s wise to make a comprehensive comparison before your final decision.
Liquid Funds and FDs
You may find that there are occasions when you have funds that lie idle for a dhor duration. For the sake of example, let’s say that you have acquired funds in March of a particular year. You may wish to plan a holiday in December of the same year. If you kept your funds in a simple savings account, you would collect very low amounts in terms of interest. Two options to grow your wealth from March to December face you. You can look at a fixed deposit to invest for a short span. This will give you a rate of interest that is fixed for a set tenure. Banks and non-banking financial companies (NBFCs) offer these, and interest rates are higher than you gain from a normal savings account.
Your other option is to consider liquid funds. Also called liquid mutual funds, these are debt funds that invest your money in fixed income instruments. These could be government securities, commercial paper, treasury bills, etc. The focus here is mainly the offer of capital protection and liquidity to investors. Liquid funds are managed by fund managers. Fund managers aim to generate better returns than you get with a mere savings account.
When you make an in-depth comparison between liquid funds and FDs, you can clearly view the benefits and drawbacks of both, based on various parameters pertaining to your investment. Finally, you can choose the investment route that suits your individual needs in a systematic way. The different parameters for comparison can help you to make a conscious decision to serve your investment goals, as you can find out below.
Risk Factors
Risk is the single most driving factor of investment today. You can compare the risk involved when you invest in liquid funds or fixed deposits below:
- Liquid Funds – These invest your capital in instruments of a fixed-income nature. However, liquid mutual funds, to some degree, may be affected by volatility of the markets and the economic conditions of the country. When compared to FDs, these carry a higher risk.
- Fixed Deposits – Extremely low in risk as investments go, these are offered by NFBCs and banks. Investments in these instruments are the safest today, with financial institutions having insurance that protects the capital invested and interest amounting to Rs. 5 lakh for each bank account.
The Returns
According to your financial objectives, you may consider the returns you potentially expect out of your investment:
- Liquid Funds – Guaranteed returns are not on the cards with liquid mutual funds. However, these funds tend to offer you better returns than those that fixed deposits can give you. However, a lot of the fund’s success depends on the calculated risks that the fund manager takes with a particular fund. Hence, investors must read offer documents with care.
- Fixed Deposits – based on your principal invested amount and your tenure, you get a fixed rate of interest on your fixed deposit. These interest rates that determine your returns are decided by the Reserve Bank of India, according to the country’s economy and financial system. Returns are higher than savings account returns, but lower than those you get with liquid funds.
The Liquidity
In case you wish to prematurely terminate your investment, you should know which one offers you an easy and cost-effective way out.
- Liquid Funds – You are permitted to redeem liquid funds at any point of time, without any charges or exit loads. However, the Securities and Exchange Board of India announced that liquid funds redeemed within seven days of holding them would incur exit loads.
- Fixed Deposits – FDs have a date of maturity and the interest accrued depends on the principal invested and term of investment. It is possible to make a premature withdrawal of your funds. However, you will be charged a penalty for this. Typically, this amounts to 1% of the interest applicable. Liquidity in fixed deposits comes at more of a cost than that incurred with liquid funds.
The Horizon of Investment
The tenure of your investment is an important variable to consider when have certain financial goals to achieve in a period of time.
- Liquid Funds – These funds offer you a maturity of a maximum of ninety-one days.
- Fixed Deposits – Fixed deposits offer you tenures ranging from seven days to ten years, so with fixed deposits, you get more ranges in tenures of maturity. This helps you to save over a long duration if you wish.
The Aspect of Taxation
Taxation is a key aspect when you make investment decisions.
- Liquid Funds – Returns from liquid funds that are held for three years or more are liable to be taxed. These incur a long-term capital gains tax of 20% (apart from indexation). If liquid funds are held for less than three years, returns are taxed based on the investor’s tax slab.
- Fixed Deposits – Fixed deposits earn interest, and this is added to the annual income of the investor and taxed according to the tax slab applicable. Furthermore, on interest payouts, the financial institution deducts a TDS amount at 10%.
A Comparison Helps
Comparisons help you to select your particular route of investment and the instrument to match your needs. Investments must be made systematically so you see some benefits in your returns with a minimal amount of risk. Rather than listen to a friend or a relative, you should assess your own requirements and goals and compare instruments to make a wise decision.
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