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Not Really As Liquid

Despite what you hear around you, liquid funds are not a better replacement to bank saving accounts…

Over the last few days, there has been a lot of talk of liquid funds being suitable for individual investors and how they are superior to savings bank as a place to keep cash. The immediate cause has been the RBI’s actions in slightly enhancing the interest rate on savings bank deposits and its simultaneous limiting of banks keeping their money in liquid funds. This prompted the talk of funds seeking to expand the use of liquid funds for individual investors since they offer a rate of return that is superior to savings bank accounts.

No doubt, this makes for interesting conversation among people who like to talk about such things but that’s about all. In practice, liquid funds are a poor fit for the kind of usage that most of us put savings bank accounts to.

First, let’s look at the basics of liquid funds. These are mutual funds that invest in extremely short-term debt instruments. The way they manage their portfolio is regulated tightly by SEBI. This tightening has been significantly enhanced after the 2008 liquidity crisis, making liquid funds effectively of negligible risk.

Currently, liquid funds returns vary in a narrow range, with most of them fitting in the 5.5 to 6.5 per cent per annum brackets. The returns may go up and down as liquidity changes in the economy, but different funds always stay in a fairly narrow range with little to choose among them.

Liquid funds are of interest only to corporate seeking to park large sums of cash for short periods. These is the only way that companies can deploy short-term (as short as a few days) surplus and earn something on it. Bank deposits are not available for such short periods. Operationally, liquid funds are tuned to absorb and redeem huge sums at short notice. For companies, the difference between keeping money in a zero-income current account and a liquid fund can be significant.

However, for individuals, the differential between savings bank interest rate and liquid fund returns can be laughably small. If you have Rs 1 lakh that you need to put away for a month, then a savings bank account would earn you Rs 333 and the liquid fund would earn Rs 500 or perhaps just a bit more. The extra couple of hundred rupees is not worth the bother. Even if the sum was Rs 10 lakh and the period was an year, the differential would be somewhere around Rs 16-18,000 depending on which liquid fund you chose. Would that be worth it? For someone who is used to dealing with funds, it could just about be worth doing it.

However, would this hyper-knowledgeable, investment-savvy person be keeping any significant amount of money in a savings bank? No way. For anyone who at all gives any thought to savings and investments, keeping money in a savings account is an embarrassment. At best, a savings bank account is a transit camp for money on its way from your income to either expenditure or investments.

The only actual use for a savings bank is emergency funds, and this is where it scores hands down over a liquid fund. A liquid fund is liquid compared to other funds but not in comparison to a savings account. Liquid funds issue neither any cheque books, nor ATM cards. Is there any situation in which an individual investor may find a liquid fund useful? Perhaps, if you have a large sum of money that has to be kept in readiness for a specific use, like buying property.

It must be noted that despite what the fund companies may say, I don’t believe they could be serious about trying to get individuals to invest small sums of money in liquid funds. Liquid funds are very low margin products and it would be hard for fund companies to make any money in such a market.