Just got a bonus, sold an asset or money saved for a purchase in the near future. It's a waste not to keep it in a savings account, but it can be a problem when you need to access it. The two popular choices that repeatedly appear are the bank fixed deposit, and the mutual fund's liquid scheme. The two are both short-term lending and borrowing, but they are very different. Here's how to do it with confidence.
What Is a Liquid Fund?
How it works
An open-ended debt mutual fund is known as a liquid fund. It buys money market and debt securities with a maturity of 91 days or less. Units are purchased, and their price is known as the NAV (Net Asset Value).
Key traits
No lock-in period – can be redeemed when required. Typically redemption is allowed as T+1, and some funds provide instant redemption up to a certain limit. No set interest rate. The returns are dependent on the securities held and on short-term interest rates. The volatility is generally low in the portfolio, though the returns are not assured as it is short-dated.
What Is a Fixed Deposit?
How it works
An FD is a money deposit into a bank that will have a set maturity period, from a couple of days to several years. The interest rate is fixed upon booking and doesn't change, you know the interest rate in advance and will know the maturity amount upon booking.
Key traits
Generally, premature withdrawals are permitted and will result in a penalty to the interest rate. DICGC insurance covers deposits up to ₹5 lakh per depositor per bank, both principal and interest. This certainty and insurance cover is typically the top advantage of an FD over liquid funds.
Liquid Fund vs FD: Side-by-Side Comparison
Here is how a liquid fund vs FD stacks up on the factors that matter most:
|
Factor |
Liquid Fund |
Fixed Deposit |
|---|---|---|
|
Returns |
Variable, market-linked |
Fixed at booking |
|
Liquidity |
No lock-in, usually T+1 |
Penalty on early exit |
|
Risk |
Low, but subject to credit and market risk |
Very low, with DICGC cover up to ₹5 lakh |
|
Lock-in |
None |
Chosen tenure |
|
Minimum amount |
Often as low as ₹100 to ₹500 |
Usually ₹1,000 to ₹10,000, varies by bank |
|
Tax |
Slab rate (recent purchases) |
Slab rate, TDS may apply |
Returns
An FD provides a guarantee while a liquid fund provides a pattern. Let's say you have invested ₹5 lakh in a six-month investment plan. If you invest ₹2,40,000 at 6.5% for a fixed deposit, you'll be able to earn a little around ₹16,000 in pre-tax interest. A liquid fund with an average return of 6.2% would give return of approximately ₹15,500 and it may be higher or lower. The difference is minimal, therefore you want to check the current rate before choosing.
Liquidity and risk
A liquid fund vs FD becomes evident during a sudden cash requirement. A liquid fund is a fund that provides liquidity; this means that you can withdraw your money without incurring any penalty, although you may be charged an exit load if you pull your money out within the first seven days. Early break can be done but a bit of interest is lost. In terms of safety, an FD's DICGC insurance provides coverage of up to ₹5 lakh. There is no cover on a liquid fund. Its safety is derived from its excellent, low maturity portfolio, so before you buy the fund, check on the quality of the fund's credit.
Tax on Liquid Funds vs FD
The tax gap has closed. Your FD interest will be added to your income and taxed at the slab rate and TDS may be deducted from interest once it reaches the threshold of the FD. The gain on the liquid fund units purchased post 1st April 2023 is also taxable at the slab rates without any indexation benefit.
Now liquid fund's tax is less advantageous. It's more about flexibility than tax savings these days. Tax conditions are subject to change; check the current tax conditions or consult a tax advisor before investing.
Which One Should You Choose?
Choose an FD if
-
You have a firm deadline for when you should receive the funds.
-
You're looking for a fixed rate and no hidden fees.
-
Flexibility is not as important to you as deposit insurance.
Choose a liquid fund if
-
You don't know how long your timelines will be or if you need only a portion of the money.
-
Investing in cash for short term and looking for a liquid fund or FD that gives you an easy withdrawal option.
-
You have money to park temporarily between payments and you own a business.
What about an emergency fund?
Many investors divide their funds into two parts: FD vs liquid fund for emergency fund planning. Have 1-2 months' living expenses in a savings account that's easily accessible. Invest the next layer in a liquid fund to have flexibility. An FD can accept money that is set aside for a specific purpose and a specific time.
Can you use both?
Yes, and at times, it is the best way to go. If money has to be paid for a fixed payment, for example, an insurance premium or tuition fee, use an FD. For any money left over, put it in a liquid fund.
Common Mistakes to Avoid
-
Pursuing the return of the previous month. The yields of the liquid funds fluctuate with interest rates, and a high rate in the present does not necessarily mean a high rate in the future.
-
Not considering exit loads and cut-off times. Prior to the cut-off you can redeem and this alters the timings of your funds.
-
Overloading one bank. Any amount over ₹5 lakh is not covered by insurance.
-
Including a liquid fund in a risk-free portfolio. It's not a no-risk situation, it's a low-risk situation.
Conclusion: Certainty or Flexibility?
The basic principle is that an FD is for certainty and a liquid fund is for flexibility. If you have your own idea of the time and are sure you will need the money, then get the FD. A liquid fund is well suited for you if you have an open plan and are looking for convenience. Many investors will do best by using both.
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Mutual fund investments are at risk of market risk. Thoroughly read all documents related to the scheme.