Why It’s Time To Shift To Liquid Funds From Savings And Current Account?

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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