Middle-class household investments often circle around a debate between liquid funds & fixed deposits. Many of their arguments lie in core definitions. So, let’s start by understanding what they mean.
Fixed Deposits are secured investment schemes offered by banks with fixed interest rates that are usually higher than savings accounts. At their core, they’re less liquid and considered to be less risky as the fixed interest rates make them not vulnerable to market fluctuations.
Liquid Funds are mutual funds that are invested in debt instruments. These are short-term funds with high liquidity & substantial returns.
Over the last few decades, while the investment scenario across the globe has been bleak, India’s SIP has generated consistent returns (in terms of the face value of money) for small investors/middle-class households.
- Liquidity – Liquidity refers to the ease with which stocks can be liquidated, or funds can be withdrawn. Fixed deposits are typically tricky to liquidate. In some cases, if the investor wishes to liquidate funds before maturity, they might have to forego the interest they have earned and are going to earn in the future.
Liquid funds have fewer restrictions, such as these. However, liquid funds are likely to subject to market fluctuations.
- Lock-in period – Liquid funds typically do not have a lock-in period. FDs, on the other hand, have an average maturity period between 1 to 5 years. As mentioned earlier, if the depositor wishes to withdraw the fund before maturity, they have to forego the interest. Along with that, some funds may also require depositors to pay the penalty for pre-mature withdrawal.
Liquid funds, on the other hand, may have a short investment period of 90-91 days.
- Returns on Investment (RoI) – For FDs, the RoI is usually pre-determined by institutions/banks that issue them. In India, they’re generally upwards of or around 7%.
For liquid or debt funds, they vary depending on the market situation. Depending on such circumstances, the likes of liquid mutual funds may or may not be more lucrative than fixed deposits. A stagnant market may insinuate lower interest rates for most liquid funds except mutual funds.
In a thriving market, debt securities offer a higher rate of return. This is because of an anticipation of higher returns that comes with investments in an economy on the rise.
This is usually the ideal time for investors to indulge in high-risk investments.
- Tax & related benefits – Investing in liquid funds entitles investors to tax indexation, eventually lowering the tax burden on them.
After indexing, the long-term capital benefits on liquid funds held by investors for over three years can amount up to 20%. The short-term benefits, on the other hand, are chalked up according to the applicable tax slab.
For investments on FDs, the returns are added to the overall income of the investor, thereby increasing the aggregate income. The sum is subjected to a tax slab based on the total amount.
Ergo, if an investor’s aggregate income after returns belongs to the uppermost bracket, they are liable to pay 30%.
On top of that, the bank can have a TDS, if the total income on the FD exceeds INR 10,000.
- Risk – Financial crisis like inflation directly or indirectly reduce an investor’s income when it comes to liquid funds. As mentioned earlier, the interest rates on liquid funds are subject to market fluctuations. This affects the Net Aggregate Value.
Fixed Deposits, on the other hand, are immune to fluctuations as the rate of interests are set and are on the face value of the money invested.
Now that we’ve evaluated the core differences between the two. Let’s have a look at some of their features that not only define them but also help in an investor’s decision making.
- Banks inform the investor about interest rates for different sums and different periods
- Usually, FD durations vary from 1 to 5 years
- Offer documents contain detailed information on penalties if the FDs are withdrawn before maturity
- Banks deduct TDS for FD incomes over INR 10,000
- If TDS is lower than the tax slab interest rate, the investor is liable to pay interest on the FD when they file their tax returns
- FDs currently provide interest rates between 7 & 9 %
- Senior citizens usually get a higher rate or returns on FD investments
- The amount is invested directly in money market instruments such as treasury bills & term deposits
- Assets have a low maturity period
- Entry & exit from any scheme is relatively easy
- In a thriving market, the rate of return is high
Liquid funds don’t usually guarantee returns, however active participation in investments & divestments and proper management of the same help maintain healthy gains.
There is no answering whether liquid funds are safer than FDs or vice versa. It all depends on factors internal or external to the investor such as inflation, current income et al. For investors who aren’t up to date with external factors, it is advisable to seek the advice of an expert who is present with such matters.