Financial Year 2016-17
started on a positive note for Savings Bank account customers, under the new
guidelines of the Reserve Bank of India, they are set to receive interest rates
on a quarterly basis or shorter intervals. This directive will fetch slightly
better returns for customers, but the question remains… is it enough?
The answer lies in the
fact that in spite of deregulation of savings interest rates by the RBI years
back, majority of the banks continue to offer 4%
rate. The state of current accounts is far worse as
they are simply denied of this privilege. However, be it lack of time or
knowledge, many of us miss out on this opportunity called
“Liquid Fund” to
tap the potential of earning higher returns without locking up surplus cash.
What Are Liquid Funds?
Liquid funds mainly
invest in securities bearing short-term maturities such as treasury bills,
certificates of deposits and commercial paper. The best part is these funds do
not charge entry or exit loads, letting investors withdraw their amount freely
without having to worry about lock-in period.
Category
|
1 Month
|
3 Months
|
1 year
|
3 years
|
5 Years
|
Liquid Fund
|
0.63
|
2.0
|
8.0
|
8.7
|
8.8
|
Savings Account
|
0.33
|
1.0
|
4.0
|
4.0
|
4.0
|
Difference
|
53%
|
50%
|
50%
|
46%
|
45%
|
*Source: ValueResearchOnline
Investors can receive
funds the next business day of placing redemption, which provides daily liquidity. These
funds are the most ideal investment tool for not only individuals, but also for
non-individual entities to put their idle
surplus to use and earn interest which otherwise is not
available under current account. A report from the Association of Mutual Funds
in India (AMFI) revealed that increasing number of corporates invested in
liquid and money market schemes that saw an inflow of $1.3 trillion in
April’2016.
Because these funds are
exposed to only money market linked risks, the possibility of
volatility or negative returns is remote due to short maturity period of the
debt instruments. In the said savings category, the scope of
returns is also higher and better than a savings account and current account.
On an average, a liquid fund can deliver returns between 7% and 9% or higher
annually, which is based on their past performance over the last five years.
From Tax Aspect
Many investors shy away
from this alternative due to tax worries. However, liquid funds continue to
reign over savings account as far as taxation is concerned. For instance, if 8%
annual returns are expected from liquid fund investments, then post-tax returns
for individuals falling in 10%, 20% and 30% tax bracket stand at 7.2%, 6.4% and
5.6% respectively. In a nutshell, post-tax returns from a
liquid fund beats the savings bank interest by a phenomenal margin while it is
an essential investing mode for corporates.
Besides this, liquid
funds when held for less than 3 years attract short-term
capital gains tax, which is taxed as per an individual’s tax bracket. Thus,
choosing growth option over dividend option is appropriate for those falling in
10% or 20% tax slab. On the other hand, investors in the highest tax slab,
i.e., 30% should ideally opt for dividend reinvestment option. The rationale
behind this is to lower the tax outgo as dividend distribution tax (DDT) paid
by fund is 28.84% (25% +12% Surcharge + 3% Cess), which is reflective in NAV
(Net Asset Value).
When held for more than
three years, returns from liquid funds will be taxed as long-term capital gains
at 20% with indexation.
Length of time
It is clear that liquid
funds score over savings account, but time duration to remain invested in these
funds also matters. Any investment above three months to six months might lose
opportunity cost of earning higher returns, which is available in other short
term income funds. Hence, reviewing the portfolio and taking an appropriate
action is advisable.
Important element of
Financial Planning
Finally, it cannot go
without saying as how liquid funds are key to financial planning. Investors
should ideally park their emergency corpus in a liquid fund to ensure they earn
higher interest rate over savings account without compromising access to funds.
The best part is investors can start investing in liquid funds with as little
as Rs 5,000, which is equivalent to minimum balance maintained in most of the
savings bank accounts.
About the author: Reenika
Avasthi is associated with Inverika Investment Solutions LLP as a Content Writer
and Financial Planner. Reenika Avasthi is a Certified Financial Planner and a
freelance content writer in the field of personal finance. Her interest in
writing and spreading investor awareness motivated her to start blogging.
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