Liquid funds are a class of debt funds that invest in money market instruments with short-term assured interest rates. These include treasury bills, commercial papers, high-rates corporate and government bonds. Liquid funds invest in these high-rated money market instruments to provide capital preservation. Such funds are short-term in nature and can get withdrawn without much hassle.
If you are confused between FD or liquid funds and the right option to invest in, let us help you by differentiating between the two based on different parameters like risk, availability of funds, returns, liquidity and taxations.
Risk - This is one of the primary factors you should consider when choosing between FD or liquid funds as well as all other investment options. If you have a conservative investment portfolio and are risk-averse, fixed deposits are a safe bet for you. They offer a fixed rate of return that is not market dependent and therefore, come with minimal risks. On the other hand, investing in liquid funds
can get considered slightly riskier because they get subjected to a variety of factors that influence their NAV. Now if you have already begun to wonder 'are FDs better?' you must remember that even though liquid funds
have a comparatively higher risk, they have other additional benefits. Their NAV does not fluctuate often owing to their short-term horizon, and they are also better equipped at performing against inflation as they can pace up, unlike fixed deposits. Since inflation tends to erode your savings, the above benefit offered by liquid funds acts as an added advantage.
Availability of funds - Fixed deposits require a lump sum investment for a specific tenure that varies from bank to bank. Liquid funds instead allow a fixed amount of investment every month as part of a Systematic Investment Plan (SIP). While both have their advantages, thinking about 'are FDs better' or 'are liquid funds better' from this aspect can be a tad bit confusing as it primarily depends on your investment plan and fund requirements. If you prefer a lump sum investment at the start, fixed deposits would be a better option. However, if you consider that monthly payment would suit you better, you could go for liquid funds.
Returns - Fixed deposits offer a specific predetermined interest rate that does not change during the entire tenure of investment. As the return on investment for FDs does not depend on market fluctuations, they can provide a secure source of fixed income or return. Usually, FDs with higher tenures offer a higher rate of interest
and vice-versa. Liquid funds returns, on the other hand, are not based on a fixed rate of return and therefore, get affected by the ups and downs in the market. That is the reason liquid funds may manifest varying returns on investments when the economy is volatile and unstable. However, a point to note here is that liquid funds mostly invest in instruments that come with a short period of up to 91 days. That can allow you to purchase new commercial papers and securities at a higher rate of return as soon as the old ones expire.
Liquidity - A fixed deposit typically comes with a lock-in period that ranges from 1-5 years. Since they have a fixed tenure, a pre-mature withdrawal in the case of FDs
usually attracts a penalty. Liquid funds tend to have higher liquidity because of the absence of any lock-in period and allow a quick disbursal of funds into your account.
Taxations - Weighing investments based on their tax treatments is a common way of choosing between different possible options. When it comes to tax on fixed deposits, the returns earned get added to your aggregate income, and the total gets subjected to the rate of tax applicable to you as per the tax slabs specified by the Income Tax Act, 1961. The returns above Rs.10000 also get subjected to TDS (tax deducted at source) at the rate of 10%. In the case of liquid funds, the tax gets determined based on the period of holding of the funds. For long-term capital gains on liquid funds held over three years, the tax rate applicable is 20% post indexation. Short-term gains on such funds get taxed under your tax slab.