Liquid Funds Vs Savings Accounts: Where to secure youremergency funds?
Savings Account
Savingsaccount is simply a type of bank account that allows you to safely deposit andwithdraw money held at a bank or financial institution while earning interest.Though savings accounts do not provide a decent interest rate, their safety, easeof access and reliability makes them an idle choice to save your hard-earnedmoney for short-term needs.
Liquid Funds
Liquidfunds are a type of debt mutual funds – open-ended schemes that primarily investmoney in short-term money market instruments such as certification of deposits(CDs), government bonds, treasury bills, and other market instruments maturingwithin 91 days. Liquid funds provide high liquidity to the investors where theredemption request is processed within 24 hrs. There is no entry and exit loadsapplication to liquid funds, further easing the overall load on the investor.
Comparison: Liquid Funds Vs SavingsAccount
| Parameters | Savings Account | Liquid Fund |
| Ease of Operation | One can withdraw money through the savings account through the ATM machine and cheque. | One cannot directly withdraw money from the liquid fund. One has to put a redemption request to withdraw money from the liquid fund that takes 1-2 working days. Once processed, the money will be transferred from liquid funds to the bank account for withdrawal. |
| Rate of Return | After demonetization, banks have considerably reduced the interest rates in savings accounts. Now banks are offering near around 3.5-5 percent. There are some banks that offer high-interest rates but these banks have a high minimum balance to maintain. | Liquid funds involve some extent of market risk since the amount invested in money market instruments, which also makes them capable of giving higher returns than savings accounts. Liquid funds offer considerably higher returns near around 7-9 percent. |
| Tax Benefits | Up to Rs. 10,000 of interest is tax-free. So, if the rate of return is 3.5 percent, you can park up to Rs. 2.85 lakh in a savings account. However, this limit will be less if the interest rate is high. | Due to the benefit of indexation, the liquid funds entail a lower tax expense. Liquid funds held for less than 3 years are taxed as a short-term capital gain (STCG) at 20 percent after indexation. But, if held for more than 3 years, taxed as per income tax slab. |
Summary
Fromthe perspective of financial planning, all your investments must begoal-driven. Whether your goal is to build funds for long-term or short-term,one must always look out for investment avenues that can help you in yoursurplus cash. Having contingency funds at disposal for unforeseen emergencysituations make it easy to cover unexpected expenses that cannot be covered bymedical insurance, fixed deposits, or other long-term investment options withmaturity.
Therefore,to meet the emergency needs, the cash at hand cannot be locked away in aninvestment option or asset but has to be kept in liquid form to get easy-accessanytime in the future.
Whenit comes to creating emergency funds, one must look for things – safety, liquidity,and returns. For most investors, a savings account is the preferred option topark their surplus funds. The savings account is the most liquid instrumentavailable to investors who can use this instrument for immediate cash.
Also,the safety is very high in a savings account since the amount invested is notmarket-linked and the deposited amount is safe from volatility in the market. But,from the return standpoint, the savings account is not the ideal option forkeeping your short-term funds. Theinterest received on the deposited amount in savings account varies withbank-to-bank and fall in the range of 3.5-5 percent on an average.
Nowthe key question is what’s the better alternative of savings account?
Well,there is another option to invest your short-term funds i.e. liquid funds. Liquidfund is a kind of debt mutual funds. It is an open-ended scheme that investsyour money in money market instruments like certificates of deposits (CDs),treasury bills, and other short-term instruments maturing within 91 days. But,on average, liquid funds have a portfolio with an average maturity of fewerthan 40 days. The liquid funds provide high liquidity without any lock-inperiod. The redemption requests are processed within 24 hrs where many mutualfund houses provide instant redemption facility where you can withdraw up toRs. 50,000 per day.
From the return standpoint, the savings account falls short from liquid funds. Theliquid funds generate significant returns – around 7-9 percent on an average –compared to 3.5-5 percent given in the savings account. Though the liquidfunds offer higher returns than a savings account, they are exposed to creditrisks which may impact the fund’s liquidity. However, the liquid funds carry avery low risk which can be compared to the savings account. But, when you areinvesting any mutual fund or liquid fund, it will entail market risk.
Inshort, the liquid fund is a good alternative of the savings account wherein theinvestor’s money will be invested in money market instruments like governmentsecurities and treasury bills that hold the least amount of risk and does notcome with the penalty on premature withdrawal of funds. There are many otheraspects where liquid funds act as a convenient means to invest and earn betterreturns.
Inthis guide, will compare both investment avenues and find out which one is the better alternative for building short-term emergency funds.
liquid fundsmutual fundssavings accounts
