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Opt to invest surplus money in liquid funds

Indians’ reliance on bank savings accounts is age-old. Attracted by the promise of safety, guaranteed returns and instant liquidity, Indians have overlooked the fact that these accounts have offered just 4% interest, on average, in the past 10 years. There are relatively better alternatives to park surplus money, one being liquid mutual funds which potentially offer relatively higher yields (with slightly higher risk) and liquidity.

What are liquid funds?

​ Liquid funds are open-ended schemes that invest in debt and money market securities such as certificates of deposit (CDs), commercial papers (CPs), and zero-risk government Treasury bills (T-bills) with maturity of up to 91 days. ​Liquid funds offer easy access to money just like a savings account. Investors can mostly encash their investment in liquid funds in one day after placing the redemption request. They carry the lowest risk of all debt funds and can be used by those who are planning to build a corpus for contingencies.

Table 1: Liquid funds versus savings deposits

Why liquid funds?

Liquid funds offer several benefits:

Easy liquidity

One of the biggest lures of savings accounts is instant liquidity. Many liquid funds aims to match this by offering instant liquidity through a mobile app, albeit this is normally capped at Rs 50,000 or 90% of the folio whichever is lower, apart from other terms and condition as applicable. Liquid funds are open-ended schemes that invest in debt and money market securities. The funds are credited to the investor’s bank account the next business day.​

Relatively better returns

Although the Reserve Bank of India (RBI) has deregulated interest rates since October 2011, most banks still offer 4% returns, on average, on savings deposits. In comparison, liquid funds (as represented by the assets weighted index created out of CRISIL ranked liquid funds) gave a higher one-year point-to-point returns of 7% as on August 31, 2018.

Notes:

Liquid funds’ return, represented by assets weighted index consisting of CRISIL ranked liquid funds for the period analyzed Savings bank rate index is created from the average rate of return provided by top three banks (by total deposits) - public and private Point-to-point returns for liquid funds and saving bank index for the period ended August 31 2018 Returns for 1-year period is absolute and period greater than one year are annualized returns Source: CRISIL Research

On rolling one-year returns, too, liquid funds have outperformed bank savings deposits since 2001 (see Chart 1).

Note:

Liquid funds’ return, represented by assets weighted index consisting of CRISIL ranked liquid funds for the period analysed Average one-year daily rolling returns of assets weighted index consisting of CRISIL ranked liquid funds since its inception in April 2000 Savings bank rate index is created from the average rate of return provided by top three banks (by total deposits) - public and private Data as on August 31 , 2018 Source: CRISIL Research

Tax advantage*

In case of savings accounts, interest earned up to Rs 10,000 in a financial year is exempted from tax. However, as per current tax rates returns from liquid funds are taxed as per the income tax bracket, if held for less than one year. If held for more than three years, the tax rate is 22.66% with indexation which can further reduce the tax liability based on the prevalent inflation rate.

In terms of post-tax returns, liquid funds can give higher post-tax returns even after considering the Rs 10,000 tax exemption offered by savings accounts. Liquid funds held for less than three years are taxed as per the income tax slab. For instance, an investor invests Rs 1 lakh each in a savings account and liquid funds. At 4%, the savings account will yield Rs 4,000, which is tax exempted, while liquid funds will fetch Rs 7,220 at 7.22% (average one-year daily rolling returns of assets weighted index created out of CRISIL ranked liquid funds since its inception in April 2000 till August 31, 2018) 2Source: CRISIL Research.

Tax payable as per the tax bracket of 10%, 20% and 30% will be Rs 722 (10%*7,220), Rs 1,444 (20%*7,220) and Rs 2,166 (30%*7,220), respectively. Hence, the net amount received by investors post taxes will be Rs 6,498 (7,220-722), Rs 5,776 (7,220-1,444) and Rs 5,054 (7,220-2,166), respectively.

*In view of the individual nature of the tax consequences, each investor is advised to consult his/her own tax consultant with respect to specific tax implications arising out of their participation in investments. The tax rates are as per current tax laws and are subject to change.

How to invest in liquid funds?

Investors can invest in liquid funds either directly or through a financial advisor. They can do so offline through a physical application, or online or through a mobile app. (https://www.sbimf.com/en-us/ways-to-invest/online-portal).

Summing up

Liquid funds are a good alternative to savings deposits and can be used to park surplus cash with potentially better returns and tax benefit. However, liquid funds are exposed to credit and liquidity risks, amongst other risks. Investors must carry out basic due diligence and read the offer documents carefully before investing.

This material is for general information only and not intended to be relied upon as investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Recipient are advised to seek independent professional advice before making any investments.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.