Liquid Funds vs Savings Accounts: Why Liquid Funds Offer Smarter Returns

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When most investors think of mutual funds, equity-oriented schemes often come to mind. However, the world of mutual funds is much broader and includes stable, low-risk options suitable for short-term goals and emergency funds. Liquid mutual funds have emerged as an attractive alternative to traditional bank savings accounts, offering better returns with minimal risk.

In this guide, we’ll explain everything you need to know about liquid funds — how they work, their benefits, and how they compare to savings accounts.

What Are Liquid Funds?

Liquid funds are a category of debt mutual funds that invest primarily in short-term, high-quality money market instruments such as treasury bills, government securities, and corporate bonds.

Investors can invest in liquid funds for any duration, and withdrawals are typically processed quickly, offering almost instant access to cash.

Why Consider Liquid Funds?

1. High Liquidity

Investors can redeem their investments anytime without significant delays, making them an excellent option for parking surplus funds.

2. Minimal Exit Load

Unlike equity mutual funds, which may impose an exit load if redeemed within a year, liquid funds have a graded exit load that diminishes after the first few days and becomes zero after seven days.

3. Low Risk Profile

 This limits their exposure to interest rate fluctuations and minimizes the risk of default, making them one of the safest mutual fund options.

4. Superior Returns Over Savings Accounts

While typical savings bank accounts offer 2% to 3% interest, liquid funds can provide returns in the range of 6% to 7% annually, depending on market conditions.

How Do Liquid Funds Work?

The fund manager of a liquid fund carefully constructs a portfolio of debt and money market instruments with maturities less than 91 days. By focusing on high-rated securities and keeping the maturity short, the fund minimizes risk and maintains stable returns.

Who Should Invest in Liquid Funds?

• Short-Term Investors: Ideal for individuals seeking to park their money for a few days to a few months.

• Emergency Fund Builders: Liquid funds are excellent for maintaining an emergency corpus due to easy access and better returns compared to savings accounts.

• Conservative Investors: Those looking for low-risk avenues with relatively stable returns.

• Investors Seeking Higher Returns than Savings Accounts: For those holding excess money in a bank account, liquid funds offer a smart alternative for better returns without significantly higher risk.

Taxation on Liquid Funds

Liquid funds fall under the debt mutual fund category and are subject to capital gains taxation:

• Short-Term Capital Gains (STCG): If redeemed within three years, gains are added to the investor’s income and taxed as per the applicable income tax slab.

It’s important to plan redemptions wisely to optimize tax liabilities.

Liquid Funds and Systematic Transfer Plans (STPs)

Liquid funds are often used for Systematic Transfer Plans (STPs), where investors gradually shift their investments into equity mutual funds over time. This strategy is beneficial for those who want to mitigate market timing risks and invest systematically in equities.

Additionally, when equity markets are overvalued, funds can be moved back into liquid funds, offering a safe parking zone until the next opportunity.

How Are Liquid Funds Different from Arbitrage Funds?

While both serve as short-term investment vehicles, liquid funds are less volatile and better suited for ultra-conservative investors compared to arbitrage funds.

Conclusion: Should You Invest in Liquid Funds?

They strike a balance between safety, liquidity, and returns, making them ideal for parking emergency funds or managing short-term cash needs.

However, before investing, it’s essential to assess your financial goals, compare different liquid fund options, and consider consulting a certified financial advisor to select the fund best suited to your needs.