Here are a few points which highlight the risk-return perspective of Liquid Funds vs. Savings Bank A/c as an investment:
Those of you who procrastinate and mostly park money in saving bank A/c only instead of Liquid Funds; It’s time to wake up and smell the coffee. The moment has arrived to tweak your investment strategy a bit. The recent spur of demonetization has made banks to relook the saving bank deposit rates. Chances of a rate cut are looming large over depositors. Banks may reduce the savings rate by as much as 50 basis points. One basis point is one-hundredth of a percentage point.
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So, if you were enjoying interest at 4% on your savings bank get ready for a plunge in earnings. You may be wondering what gave rise to such a terrible move! The motivation behind this is to contain the operational costs. Banks have accumulated large deposits of cash since demonetisation. But corresponding credit growth was lacklustre. Moreover, removal of charges on ATM withdrawal above limits has taken a toll on their fee-based income. Thus, carrying on banking with the same rates on deposits would become very unviable.
Already the rates on term deposits are touching the floor. With a decline in the saving bank rates, it would be a complete washout for investors surviving on fixed-income investments. Especially, senior citizens and retirees would have to face a tough time shortly.
Is there a way out for better returns elsewhere?
Also read: Best Performing Arbitrage Funds for 2017
Of course, there is!
You may go for Liquid Funds as a viable short-term investment opportunity.
Liquid Funds- A Prelude
Liquid funds are meant for the low-risk seeker who has a short investment horizon of say 1-3 years. It is a convenient and cost-effective tool to earn market returns on investment of short-term surplus funds. These funds invest your money in fixed-interest bearing short-term instruments i.e. treasury bills, commercial paper, certificate of deposit, etc. of up to 91 days. Investment in liquid funds provides you liquidity, the safety of capital & moderate returns.
From liquidity aspect, you may redeem any part or the entire amount of your investment at a day’s notice. Most of the liquid funds do not levy any exit loads. Even from earning a regular income perspective, Liquid funds are highly recommended. These come with Daily Dividend, Weekly/Monthly Dividend and Growth Option.
Liquid funds are safe investments on both risk and volatility counts. Low risk is ensured as the fund manager includes only those securities in the portfolio which have a high credit rating. On account of low average maturity, your money would stay invested for a relatively shorter period. Thus, liquid funds score low on the volatility of returns.
Liquid Funds vs. Savings Accounts – A Risk-Returns Perspective
It would be highly suggestive to draw a comparison between Liquid Funds and Savings Bank Account as an investment haven.
On a risk continuum, saving bank accounts are regarded as the safest of all the investment havens. These are not subject to any market risk as your account balance isn’t affected by fluctuations in the capital market. But they are affected by the interest rate regime. The deregulation of saving bank account rates by RBI in 2011 ripped apart its fixed-income generating ability. Now, banks are free to adjust the deposit rate to suit their operational cost. Moreover, they are subject to default risk i.e. the inability of the banks to honour your payments on demand. So, now you know that they are not as safe as they may seem.
Liquid funds are riskier instruments as compared to saving bank accounts. The NAV fluctuates according to the changing interest rates in the economy. It may in turn slightly waver your actual returns from expected returns. However, these have very rarely delivered any capital losses.
From returns perspective, liquid funds are better investment option than saving funds as goes the prudence. Liquid funds have found to yield returns in the range of 8-8.5%, on an annualised basis. It is notably higher than the returns offered in the 4-6% bracket by a savings bank account.
Based on Valueresearch data, the average historical returns of liquid funds as on 27 December 2016 are as follows: 1 year (7.53%), 3 year (8.25%), 5 year (8.59%), 10 year (7.81%)
Liquid funds are treated differently from savings bank account as regards tax.
The interest earned on a saving bank account attracts a tax incidence, and it will form part of your overall taxable income. You will be taxed as per your income tax bracket. However, under Sec 80TTA, you may claim a deduction on interest earned up to Rs 10000. So, it looks quite a costly proposition for the investors who fall in the high-end tax slab.
The dividend distributed on Liquid funds is subject to Dividend Distribution Tax at 28.84% in the hands of investors. The tax on capital gains differs for short-term and long-term. If you redeem your investments before 3 years, then you would be taxed on your short-term capital gains. The gains would form part of your taxable income and be taxed as per your income slab. If you exit the fund after 3 years, the gains would be treated as long-term capital gains (LTCG). LTCG are taxed at the rate of 20% with the benefit of indexation.
From a tax angle, liquid funds are favourable options for those in the higher tax bracket having an investment horizon of more than 3 years.
Top 5 Liquid Funds for 2017
While selecting a liquid fund, you need to probe factors more than just returns. After all, the quantum of returns in your kitty depends upon a robust investment strategy of the fund manager.
So, consider the fund history among the qualifiable and financial ratios among the quantifiables. Choose a fund which has a high Sharpe & Sortino, low Standard Deviation, high Alpha, low beta and low expense ratio.
Based on an in-depth analysis, you may try hands on the liquid funds as given in the table below:
All in all, as a comparatively lucrative investment, liquid funds give higher returns than saving bank accounts, and it makes sense to keep your investible cash in liquid funds.