Can liquid funds be an alternative to savings accounts?

Dec 25, 2016 13:30 IST 824 reads,

Generally, in India, people save their money in their saving accounts so that they can withdraw their money whenever required. But the interest rate offered by banks on saving account is 4% p.a. compounded quarterly. However, a person can invest in FDs for higher interest rates but they are not liquid as compared to saving accounts. But, now banks have also slashed the interest rates on FDs.

The returns after paying taxes are even lower and after adjusting inflation, returns are even more pathetic.

TenorsRevised For Public
w.e.f. 17.11.2016
Interest rate after tax
(30% tax bracket)
Real Interest rate
(assuming 5% inflation)
7 days to 45 days5.50%3.80%0.50%
46 days to 179 days6.50%4.50%1.40%
180 days to 210 days6.80%4.70%1.70%
211 days to less than 1 year7.00%4.80%1.90%
1 year to 455 days6.90%4.80%1.80%
456 days to less than 2 years7.00%4.80%1.90%
2 years to less than 3 years6.90%4.80%1.80%
3 years to less than 5 years6.50%4.50%1.40%
5 years and up to 10 years6.50%4.50%1.40%

Source: SBI website, IIFL Research; Note: Interest rates are for Retail Domestic Term Deposits below Rs 1 crore

So the question is how an investor can have both liquidity and higher returns. In my opinion, liquid funds are one of the best substitutes of saving accounts because they are highly liquid and have given higher returns than saving accounts.

Liquid funds are debt mutual funds that invest in commercial papers, treasury bills, certificates of deposit which are expiring in 91 days. Therefore, it has the very low average maturity and modified duration. Thus, interest rate risk is very low, unlike income funds. In addition, the liquid fund is highly liquid, if a person places a redemption order before 2 pm the funds get transferred to his account by 10 am next morning. Furthermore, there is no exit load. The liquid funds have better tax benefits than saving account too.

Table: Comparison between Liquid funds and savings accounts-

 Savings FundsLiquid Funds
Return4.00%7.0% - 8.0%
Real Return (Assuming 5% inflation)-1.00%1.9%-2.9%
Returns after tax (30% tax bracket)2.80%4.8%-5.5%
Short-term capital gain taxInterest earned is taxable as per investor’s applicable income tax slab.Short-term capital gains are added to the income of investors and taxed based on investors’ applicable income tax slab tax rates.
Long-term capital gain taxNo change in taxation, same as the short-term capital gain tax.A 20% tax is levied on Long-term capital gains after indexation.
Ease of OperationA person can withdraw his money deposited in saving account by using debit card.Easy redemption; an investor can get the money in his account next morning by 10 am if he puts a redemption order before 2 pm.

So, if you have kept your money in saving account and earning a negative real interest rate, open an account with IIFL and invest your money in liquid funds in just one click through IIFL MF website or by IIFL MF app.

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