Liquid Funds vs Savings Accounts

Liquid Funds Vs Savings Accounts: Where to secure your emergency funds?

Savings Account

Savings account is simply a type of bank account that allows you to safely deposit and withdraw money held at a bank or financial institution while earning interest. Though savings accounts do not provide a decent interest rate, their safety, ease of access and reliability makes them an idle choice to save your hard-earned money for short-term needs.

Liquid Funds

Liquid funds are a type of debt mutual funds – open-ended schemes that primarily invest money in short-term money market instruments such as certification of deposits (CDs), government bonds, treasury bills, and other market instruments maturing within 91 days. Liquid funds provide high liquidity to the investors where the redemption request is processed within 24 hrs. There is no entry and exit loads application to liquid funds, further easing the overall load on the investor. 

Comparison: Liquid Funds Vs Savings Account

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

From the perspective of financial planning, all your investments must be goal-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 your surplus cash. Having contingency funds at disposal for unforeseen emergency situations make it easy to cover unexpected expenses that cannot be covered by medical insurance, fixed deposits, or other long-term investment options with maturity.

Therefore, to meet the emergency needs, the cash at hand cannot be locked away in an investment option or asset but has to be kept in liquid form to get easy-access anytime in the future.

When it comes to creating emergency funds, one must look for things – safety, liquidity, and returns. For most investors, a savings account is the preferred option to park their surplus funds. The savings account is the most liquid instrument available 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 not market-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 for keeping your short-term funds.  The interest received on the deposited amount in savings account varies with bank-to-bank and fall in the range of 3.5-5 percent on an average.

Now the 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. Liquid fund is a kind of debt mutual funds. It is an open-ended scheme that invests your 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 fewer than 40 days. The liquid funds provide high liquidity without any lock-in period. The redemption requests are processed within 24 hrs where many mutual fund houses provide instant redemption facility where you can withdraw up to Rs. 50,000 per day.

From the return standpoint, the savings account falls short from liquid funds. The liquid funds generate significant returns – around 7-9 percent on an average – compared to 3.5-5 percent given in the savings account. Though the liquid funds offer higher returns than a savings account, they are exposed to credit risks which may impact the fund’s liquidity. However, the liquid funds carry a very low risk which can be compared to the savings account. But, when you are investing any mutual fund or liquid fund, it will entail market risk.

In short, the liquid fund is a good alternative of the savings account wherein the investor’s money will be invested in money market instruments like government securities and treasury bills that hold the least amount of risk and does not come with the penalty on premature withdrawal of funds. There are many other aspects where liquid funds act as a convenient means to invest and earn better returns.

In this guide, will compare both investment avenues and find out which one is the better alternative for building short-term emergency funds.