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Liquid Funds v/s Bank FDs

Liquid funds are ideal for short periods of less than 6 months, as they offer superior liquidity than bank FDs

Can you please guide me with concept of savings through liquid funds as opposed to fixed deposits and how to filter the best one from the market?
- Paresh Bhalia

Liquid funds are open end schemes that invest in securities with maturities of upto 91 days; this could include treasury bills, money market instruments and very short term corporate paper. They allow investors to park their funds for a few days or months, avail of anytime liquidity, and earn returns for the holding period. Because they earn returns from market instruments, liquid fund returns can rise or fall depending on market rates. For very short debt, market interest rates depend on the liquidity situation.

The recent budget has made changes to taxation of non-equity funds in order to eliminate the tax arbitrage which debt fund investments enjoyed over bank FDs. Therefore, if held for less than 3 years, capital gains from liquid funds would now be added to investor's income and taxed at his marginal rate of tax. However, this taxation is on par with bank FDs. And taxation is not the only concern which should decide your investments. Consider the following factors too:

  • Liquid funds offer superior liquidity compared to bank FDs. Bank FDs would penalize you for pre-mature withdrawal.
  • Liquid fund returns in the last three years have been quite impressive with the category averaging 8.9 per cent on an annualized basis. But going forward market liquidity could decide rates.
  • After recent dividend distribution tax changes, it makes sense to go in for the growth option in liquid funds if you are in the 10 and 20 per cent tax slabs. Go for Daily Dividend Reinvest option if you fall in 30% tax slab.

Liquid funds are ideal for parking very short term money (less than 6 months). If you wish to invest your funds for a period between 1 to 3 years consider short term debt funds.

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