Consider these two types of people in the world – Rahul & Sameer. Rahul likes to spend surplus funds on shopping spree, a turn of the spa, movie tickets, sports event or music concerts, buy a gaming console, go for an extravagant dinner experience…the options are endless, whereas Sameer parks it safely in the bank with savings bank accounts. Though savings accounts are safe, they don’t generate significant returns which beats the purpose of saving the surplus funds.
However, there are third type of people like – Rakesh who saves the surplus funds in the liquid mutual fund. It is an alternative option to a savings account. This works like a savings account but generates higher returns and is comparatively more tax-efficient in the long run.
What are Liquid Funds?
Liquid fund is a debt fund which invests in short-term money market securities with an aim to generate regular income. Liquid funds invest in debt instruments such as commercial papers (CPs), certificates of deposit (CDs), treasury bills (T-Bills), among others with residual maturity of up to 91 days. As per SEBI guidelines, the fund is required to invest minimum of 20% in liquid assets such as cash, government securities, T-bills and repo on government securities.
Since the fund invests in short-term debt securities and is less exposed to the changing market scenarios, it is less volatile to any interest rate change that may take place. The instant redemption facility where the redemption amount is received on the same day makes this category of fund highly liquid.
Liquid Fund vs Savings Account: What’s the Difference?
Savings account is a basic bank account which can be opened by a major, minor or can be held in a joint account. It typically pay a modest interest rate usually around 2%-3% and the interest earned is taxable. Due to their safety and reliability make them a great option for parking cash and withdraw it whenever required.
In case of a liquid fund, any investment held for less than three years attracts STCG (Short Term Capital Gains) tax which is as per an individual’s income tax slab rate, while investments held for more than 3 years attracts LTCG (Long Term Capital Gains) tax which is 20%* along with indexation benefit. This means that over the long term, tax to be paid for gains made in liquid funds could be much lower compared to savings accounts.
How to invest in a liquid fund?
To start a liquid fund investment, you need to be KYC compliant before investing in any fund house. Then register with the respective fund house and generate the folio. The folio contains the information such as personal details, phone number, email id, bank account details, etc. Once a folio a generated, investor can then invest in any desired fund.
While savings bank accounts come with their own advantages, liquid mutual funds offer the opportunity for higher returns in a short time. In fact, some investors treat liquid funds as their savings accounts and manage their monthly expenses through their liquid mutual fund accounts. This is highly liquid nature, low interest rate risk, comparative tax efficiency and higher returns opportunity makes liquid funds a better option to park your surplus money in.
It is advisable to consult a financial advisor or expert before investing.