We all understand the importance of debt in our portfolios since it offers security, stability, and consistent income. It goes without saying that you cannot invest all of your funds in stocks since the danger in the case of a downturn would be simply too great. But that’s where the trouble really begins.
Bonds, debentures, government securities, bank FDs, corporate FDs, mutual funds, liquid funds, etc. are just a few of the many debt instruments you can choose from.
It can be hard to decide where to invest. While some suggest that fixed deposits are the ideal option, others favour investing in liquid mutual funds. You must choose where to invest now: in liquid funds or in fixed-income securities (FDs)?
Where do fixed deposits and liquid funds fit in??
FDs in the bank and liquid funds are not wealth generators, so keep that in mind from the beginning. You can put all of your money into money market accounts or liquid funds over the course of your life and still not have much left over. Equities play a role in wealth building, but we won’t discuss that now.
if you need to retain your money in a secure location for other obligations or for unforeseen demands. Not wealth creation, but rather principal safety and modest returns, is your major goal in this situation.
The funds must be readily accessible without a financial loss and sufficiently liquid. Capital needs to be protected more than anything else.
Despite mutual funds becoming increasingly popular, fixed deposits and recurring deposits were the only types of investments available in India for a very long time. This is mostly due to the fact that these investments are the most dependable and they guarantee principal repayment without being subject to market changes.
Due to government support and deposit insurance, people have faith in banks. Even while FDs and RDs promise returns, liquid funds can assist keep your money liquid while offering a marginally greater income.
So what are FDs and what are liquid funds?
Before choosing which of the two is better, let’s first thoroughly comprehend liquid funds and fixed-income securities. Here is a short summary of both goods.
For many people around the world, it is the most popular investment option. The Reserve Bank of India said that the share of FD accounts was approximately 58.2%.
Liquid mutual funds, on the other hand, are debt funds made up of treasury bills, commercial papers, certificates of deposit, etc. Despite the fact that liquid funds include some market risk, it is still a fairly safe investment.
It often makes investments in financial instruments with a short maturity period—less than 91 days. Despite the benefits they offer, bank FDs continue to have a very strong market or clientele since they are the foundation of every customer’s connection with the bank.
How do liquid funds and bank FDs compare on the risk parameter?
Because they are risk-free, fixed deposits have been a staple of the financial industry for a very long time. Additionally, the fact that the principal is guaranteed by the government makes it more appealing to many clients.
Liquid funds, on the other hand, carry a modest risk since their performance is influenced by market risks, shifting interest rates, etc. The market risk still exists even if liquid funds are less susceptible to changes in interest rates than G-Sec funds.
In addition to the risk issue, you should be aware that the NAV of liquid funds may experience challenges, as we witnessed in the case of Templeton in 2020.
How do liquid funds and bank FDs compare on the returns parameter?
A little higher rate is offered to senior citizens. A fixed interest rate will be used to grow your money over the course of the loan. Therefore, if you want the biggest profits, it is not the greatest option.
Profits are produced by liquid funds at interest yields of 5% to 6%. However, whenever rates increase in the market, liquid funds are probably going to provide better rates.
The advantage of liquid funds over bank FDs in terms of return is between 100 and 150 basis points.
How do liquid funds and bank FDs compare on the time horizon?
Depending on your preferences, you can choose the investment duration, and the minimum deposit should be Rs. 1000. The interest rates on a 7-day FD, however, are only 2.8% annualised.
Up to 91 days are the maximum maturity time for liquid funds. You can begin investing with as little as Rs. 1000 or as much as Rs. 5,000 each month. It is far more adaptable in terms of time horizon because it may be used to a variety of time frames.
How do liquid funds and bank fds compare on the taxation?
Bank FDs are eligible for tax deductions under Section 80C of the Income Tax Act, although a five-year lock-in is required. The interest component, however, is taxed at your top rate. Therefore, the 5% yield on an FD would actually be 3.5% after taxes if you are in the 30% tax band.
You must first keep in mind that liquid funds are classified as debt funds when discussing tax on them. If you choose a dividend plan, your dividend will be taxed at your top rate, just like an FD. Gains made in the short term—less than a year—are taxed at the highest rate.
However, if kept for longer than three years, it is taxed at a reduced rate of 20% with benefits for indexation, which further lowers the tax liability.
