When it comes to investing, the choice between liquid funds and fixed deposits (FDs) is a common dilemma faced by investors seeking low-risk options. Both instruments are designed to meet different financial needs and risk appetites, making them suitable for diverse investment strategies. In this detailed comparison, we explore the nuances of liquid funds and fixed deposits to help investors make an informed decision.
Understanding Fixed Deposits
Fixed Deposits are a staple of conservative investment portfolios, revered for their safety and guaranteed returns. By depositing a lump sum for a predefined period, investors can earn a fixed interest rate higher than that of savings accounts. The tenure for FDs can range from as short as seven days to as long as 20 years.
Investors can choose between cumulative FDs, where interest is paid at maturity, and non-cumulative FDs, which offer periodic interest payouts. The interest rates for FDs vary between 2.5% and 8.5%, depending on the financial institution and tenure chosen. Despite their lower returns than more volatile instruments like equities, FDs remain popular for their predictability and security.
Key Features of Fixed Deposits (FDs)
- Guaranteed Returns: FDs offer fixed and guaranteed returns over the tenure of the deposit, providing a predictable income stream.
- Fixed Tenure: The investment period can range from a few days to 20 years, with the interest rate remaining fixed for the chosen tenure.
- Safety: FDs are considered one of the safest investment options, with negligible risk of capital loss.
- Premature Withdrawal: Investors can withdraw their FD before the maturity date, although this may incur a penalty, affecting the interest earned.
- Loan Facility: Many banks offer loans against FDs, providing an easy liquidity option without breaking the FD.
Understanding Liquid Funds
Liquid Funds, a category of debt mutual funds, invest in short-term market instruments like treasury bills, commercial papers, and certificates of deposits, with maturities not exceeding 91 days. These funds aim to offer investors a safe parking avenue for short-term surplus with better returns than savings accounts, albeit with a slightly higher risk profile than FDs. The returns on Liquid Funds are not fixed or guaranteed, but they generally offer higher liquidity and the potential for better returns than traditional savings avenues.
Also Read More About What is Liquid Funds?
Key Features of Liquid Funds
- Short-Term Investments: Liquid Funds invest in debt instruments with a maturity of up to 91 days, making them suitable for short-term investments.
- High Liquidity: Offers the flexibility to redeem units quickly, often within 24 hours, making it ideal for investors needing immediate access to their funds.
- Variable Returns: The returns on Liquid Funds are subject to market conditions and are not fixed, potentially offering higher returns than traditional savings accounts.
- Low Risk: Although slightly riskier than Fixed Deposits, Liquid Funds are considered low-risk investments as they primarily invest in high-quality debt instruments.
- No Lock-In Period: There is no lock-in period, allowing investors to withdraw their funds at any time without any penalty (after a very short initial period, if at all).
Liquid Funds vs FD
| Parameter | Liquid Funds | Fixed Deposits (FDs) |
| Rate of Returns | Potentially higher than FDs, but not guaranteed or fixed. | Fixed and guaranteed, usually lower than Liquid Funds. |
| Liquidity | High liquidity, with most funds allowing withdrawals within 24 hours. | Lower liquidity; premature withdrawals may incur penalties. |
| Minimum Investment | Usually starts at ₹100, with some funds requiring ₹500 or ₹1,000. | Can start with as low as ₹100. |
| Investment Horizon | Primarily for short-term investments due to the nature of underlying assets (up to 91 days). | Ranges from 7 days to 20 years, suitable for both short-term and long-term goals. |
| Tax Implications | Short-term gains are taxed as per income tax slab; long-term gains are taxed at 20% with indexation after three years. | Interest is taxable as per the investor’s income slab. TDS is applicable. Certain FDs offer tax benefits under 80C. |
| Risk | Slightly higher risk compared to FDs due to market-related fluctuations. | Virtually risk-free, offering guaranteed returns. |
| Premature Withdrawal | Low or no penalty for withdrawals after a short initial period. | Typically, it incurs a penalty, reducing the interest earned. |
| Investor Profile | Suitable for investors with a low to medium risk appetite looking for short-term placements. | Ideal for conservative investors seeking guaranteed returns and low risk. |
| Tax Deduction | No direct tax benefits. However, favourable tax treatment for long-term investments. | Specific FDs offer tax-saving benefits under Section 80C of the Income Tax Act. |
| Return Assurance | Returns are not fixed or assured, varying based on market conditions. | Returns are fixed and assured for the duration of the deposit. |
Choosing Between Liquid Funds and Fixed Deposits
The choice between Liquid Funds and Fixed Deposits boils down to the investor’s priorities: liquidity, returns, risk tolerance, and investment horizon.
- For Short-term Goals: Liquid Funds may be preferable for investors seeking better liquidity and potentially higher returns for short-term financial goals.
- For Guaranteed Returns: Investors prioritising guaranteed returns and minimal risk might opt for Fixed Deposits, especially for medium to long-term goals.
- Tax Considerations: Tax-savvy investors might find Liquid Funds more appealing due to the favourable tax treatment on long-term capital gains.
Conclusion
Liquid Funds and Fixed Deposits have their merits, making them essential components of a diversified investment portfolio. While FDs offer safety and predictability, Liquid Funds provide liquidity and the potential for higher returns. When choosing between these two investment options, investors should consider their financial objectives, risk tolerance, and investment horizon.
In the quest for financial security and growth, understanding the nuances of each investment avenue is key. Whether the guaranteed returns of Fixed Deposits or the flexible, potentially higher returns of Liquid Funds, the right choice varies based on individual financial goals and circumstances. By carefully weighing the pros and cons of each option, investors can strategically position their portfolios to meet their financial objectives. Looking to invest in liquid funds? Open your Demat account with Angel One today and start investing!
FAQs
Which is a more favourable investment, liquid funds or FDs?
Both options come with their unique advantages and disadvantages. Liquid funds may offer superior returns compared to fixed deposits and are ideal for temporarily parking excess funds without a fixed investment period. They allow quick access to funds, often within 24 hours, with minimal penalties after seven days. However, liquid funds introduce a slightly higher risk level than fixed deposits.
Do liquid funds outperform savings accounts?
Yes, liquid funds tend to offer higher returns than savings accounts, albeit with increased risk, while maintaining high liquidity.
Why do liquid funds have higher returns than FDs but lower than equity funds?
Liquid funds invest in short-term debt instruments, such as money market securities, which have lower returns than equities. However, their active management allows them to yield higher returns than fixed deposits potentially.
Is it possible to withdraw from a liquid fund at anytime?
Yes, liquid funds provide the option for instant withdrawal, subject to a daily limit as per SEBI guidelines, with minimal penalties applied if withdrawals occur within the first seven days of investment.
Are investments in liquid funds considered risky?
Liquid funds are deemed low-risk investments because they primarily invest in short-term government securities and high-quality debt instruments, reducing their exposure to significant risk.