Understanding the Basics of Liquid vs Fixed Deposits
Fixed Deposits
A bank fixed deposit is a traditional method of investment in India, trusted by many. It is a go-to choice for risk-averse investors as it provides a fixed rate of return.
But, over the years, mutual funds have gained wide attention for their higher returns, and liquid funds have become a popular short-term investment option.
So which investment option should you choose?
To answer the question, you must first explore both options and understand the difference between the two. So here’s all you need to know about fixed deposits and liquid funds.
What Is A Fixed Deposit?
A fixed deposit is an instrument offered by financial institutions where you can deposit a lump sum amount at a predetermined rate for a fixed tenure.
Interest rates on fixed deposits are higher than in regular savings accounts. You can choose to receive the accrued interest on maturity or get paid at regular intervals (monthly, quarterly, half-yearly, or annually).
If you’re planning on investing in FDs, shop around for financial institutions with the best fixed deposit interest rates before opening an FD account.
What Are Liquid Funds?
Liquid funds are debt funds that invest in assured-income short-term money market instruments. The instruments generally mature within 91 days and include treasury bills, commercial papers, and high-rated corporate or government bonds.
Liquid funds provide you with protection and liquidity and are generally considered safer than other classes of mutual funds.
Difference Between Liquid Funds And Fixed Deposits
Now that we’ve understood the concept let’s look at the significant differences between fixed deposits and liquid funds.
- Risk
Fixed deposits are considered highly safe investment options since the interest rate is predetermined. Also, financial institutions usually have an insurance cover that protects your invested capital and interest up to Rs 5 lakhs per bank account.
On the other hand, liquid funds invest in money market instruments and are subject to market fluctuations. Their rates of interest vary with the change in the market. Hence, they have a higher risk component than FDs.
However, since liquid funds invest primarily in high-rated instruments, they are considered a safe class among mutual funds.
- Return
Though liquid funds do not offer guaranteed returns, they are usually higher than fixed deposits. Hence, they have the edge over FDs in terms of return.
However, you have to ensure that the fund manager is not taking excessive risk while managing the fund portfolio. Always read the offer document and check the fund manager’s experience before investing in liquid funds.
- Liquidity
Fixed deposits have a lock-in period. The interest rate on FDs is based on the maturity date and tenure. While you can withdraw your money prematurely, you will be penalized.
This is not the case in liquid funds. You can redeem liquid fund units any time after seven days of holding them without any exit load.
Hence they offer better liquidity than fixed deposits.
- Investment Horizon
While FDs offer an investment horizon of 7 days to 10 years, liquid funds mature within 91 days. You can choose to reinvest your funds after 91 days if you do not want to withdraw them.
- Taxation
The interest earned on fixed deposits is added to your overall income and taxed as per the applicable slab rate. Financial institutions also deduct a TDS at 10% on interest payments if your interest income exceeds Rs 10,000 in the financial year.
You can see the interest credited to your account and TDS deducted on the same in your FD statement.
If you invest in a tax-saving fixed deposit with a lock-in period of three years, you can also claim a tax deduction of up to 1.5 lakhs under section 80C.
In the case of liquid funds, the return on holdings above three years will attract a long-term capital gain tax of 20% after indexation. But if you redeem your holdings within three years, your returns will be taxed as per the applicable slab rate.
Who Should Invest In Fixed Deposits?
If your risk tolerance is extremely low, you should go for FDs. FDs are offered by banks and fall under the purview of the Reserve Bank of India.
This makes them one of the safest forms of investment. However, if you want to invest in FD with an NBFC, check its CRISIL rating first to ensure safety.
Also, note that the returns and tax benefits are higher for longer-term FDs. So plan your fixed deposits carefully to get the maximum benefit from them.
Who Should Invest In Liquid Funds?
Liquid funds are for investors with a medium risk appetite who want to park their surplus money for the short term. Liquid funds can generate better returns than FDs but are slightly riskier.
Since liquid funds give better returns than regular savings accounts, you can consider investing your incentives, bonus, and other gains in these funds.
Final Words
Both fixed deposits and liquid funds are excellent investment options. You can choose any of them based on your risk appetite, investment horizon, and liquidity needs.
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