Liquid Funds vs FD: Which is Better?

Investing too much in any asset class can be risky, and hence it is important that you spread out your investments across asset classes. A well-balanced portfolio has different asset classes, such as equities, fixed-income securities, real estate, and commodities. Within each asset class, there are a host of options available. For example, take fixed-income securities; we have government securities, debt mutual funds, and fixed deposits. Each of them has their own set of pros and cons. In this article, we will look at two of the most popular fixed-income securities, namely,  liquid funds vs FD and understand how they differ from each other. Let’s see Liquid funds vs FD!

What Are liquid funds?

Liquid funds are a type of debt fund that invests primarily in money market instruments such as treasury bills, commercial paper, and other short-term government securities. Also known as money market funds, they have a maturity period ranging from 7 days to 91 days. They are low-risk investments and offer higher returns than bank fixed deposits. Liquid funds are an ideal alternative for investors looking to park their excess money for 2-3 months.

Features And Benefits of Liquid Funds

• Minimum investment: Liquid funds have a meagre minimum investment. You can invest in a liquid fund with an amount as low as Rs 100.
• Entry and exit load: The fund doesn’t charge any entry or exit load. You can exit within a day of investment without any penalty.
• Expense ratio: Liquid funds have a low expense ratio ranging from 0.2% to 0.5%, which is relatively lower than other kinds of mutual funds.
• Returns: Liquid funds give predictable returns ranging from 8-9% per annum. This is higher than savings accounts and fixed deposits. However, the returns are fixed and may vary based on market conditions.
• Liquidity: Liquid funds are highly liquid and can be withdrawn anytime without penalty.
• Risk: Liquid funds are not entirely risk-free and are exposed to credit risk or default risk of the underlying securities. Hence it is important to check the credit rating of the underlying securities before investing in them.

Who Can Invest in Liquid Funds?

All investors are eligible to invest in liquid funds. However, these funds best suit investors with short-term goals and have excess cash. Since they are low-risk investments, investors with low-risk tolerance can also consider investing in these funds. Moreover, liquid funds give predictable returns. So investors looking to diversify their investment portfolio can invest in them to manage the downside risk of their portfolio.

Things to Consider Before Investing in Liquid Funds

• Financial goals: Before investing in liquid funds, you must align your financial goals with the fund’s goal. This is important because it will help you find the fund that will best suit your requirements.
• Investment horizon: Liquid funds have a very short horizon of three months. Hence you must make sure you invest in them only for your short-term goals.
• Returns: Liquid funds give higher returns than savings accounts and fixed deposits but lower returns than equity funds. Moreover, the returns aren’t fixed but predictable. However, most liquid funds give returns in the range of 7%-9%. Before investing in them, check their past performance and compare different liquid funds. Invest in the ones which have consistently performed well in the past.
• Cost: There is a wide range of liquid funds available, and you must choose a fund with the lowest expense ratio to ensure your returns are maximised.
• Risk: Liquid funds are low-risk investments and are not affected by interest rate risk. However, they are affected by credit risk. Hence before investing in them, make sure you pick funds with the highest credit rating so the default risk is minimum.

What Are Fixed Deposits?

Fixed deposits (FD) have been the go-to investments for the majority of the population for ages now. Even today, they are one of the most popular investment avenues. Banks and financial institutions offer fixed deposits at a fixed rate of interest for a fixed tenure.

Fixed deposits are financial instruments that require you to invest a fixed sum of money for a fixed duration and fixed interest rate. The bank or financial institution will pay you the interest at regular intervals or at the time of maturity. You can choose the duration of the fixed deposit, and the bank will pay the interest on it, which varies based on the duration.

The tenure of the FD ranges from 7 days to 10 years, and the interest rate ranges between 3% – 8%. Your investment is locked in for the entire duration, which means you cannot withdraw your money until maturity.

Types of FDs

There are different types of fixed deposits that banks offer, and below are some of them.

1. Standard: A standard FD has a tenure that ranges between 7 days to 10 years, and the banks pay the interest rate based on the tenure.
2. Tax saving: Investment in tax saving FDs qualify for tax deduction under Section 80C of the Income Tax Act, 1961.
3. Special: Special FDs are similar to standard FDs, but the only difference is that if you don’t withdraw the investment for a specified period, the interest rates are higher.
4. Regular income: FDs offer interest payments at regular intervals or at the time of maturity.
5. Corporate: Fixed deposits offered by corporates or companies are corporate FDs.
6. Flexi: Banks are offering flexi fixed deposit which allows you to transfer the excess amount in your savings account to the FD.

Features And Benefits of Fixed Deposits

• Minimum investment: The minimum investment in FDs can be as low as Rs 100 for some banks.
• Guaranteed returns: Fixed deposits offer guaranteed returns to their investors. This means that by the end of the tenure, you will get your interest in your account.
• High-interest rates: The interest rate of FDs is higher than savings accounts, making them an excellent alternative to saving money in a bank.
• Tenure: Fixed deposits have a duration that ranges from seven days to 10 years. So you can invest for your short-term and long-term goals and choose an appropriate tenure based on your goals.
• Tax saving: Tax saving FDs offer tax benefits on the investment. They qualify for tax deduction under Section 80C of the Income Tax Act, 1961.
• Loan against FDs: Although FDs have a fixed tenure, and the investment is locked in for the entire duration, you can take a loan against it. All banks offer loans against FDs at a predetermined interest rate.
• Reinvestment: Once your FD matures, you can reinvest in the same FD for the same tenure at the current interest rate.
• Partial and premature withdrawals: FDs have a lock-in period, and you cannot withdraw your investment until maturity.

Who Can Invest in Fixed Deposits?

Fixed deposits are investments that pay guaranteed returns and are risk-free investments. Hence, they suit investors looking for fixed returns and have low-risk tolerance levels. Moreover, since they have tenures ranging from seven days to 10 years, investors with short and long-term goals can consider investing in them.

However, they have a fixed duration and hence low liquidity. Investors who are willing to stay invested the entire duration should only consider investing in FDs. This investment also suits investors looking for regular income. By opting for regular interest payouts, you can earn passive income from FDs.

Things to Consider Before Investing in FDs

• Investment goals: Your investment goals can determine your investment duration, which will ultimately determine the tenure of your FD.
• Minimum and maximum deposit: The minimum and maximum deposit for FDs varies from bank to bank.
• Interest rate: The interest rate varies from bank to bank across tenures; choose a bank which offers the highest interest rate.
• Inflation rate: Inflation can reduce the real return on investment.
• Tax: The interest on FDs is taxable as per your tax slab. Moreover, the bank also deducts TDS (tax deducted at source) if the interest income exceeds Rs 40,000. Hence you must consider taxation before investing in FDs.
• Premature withdrawal clause: Different banks have different premature withdrawal clauses. Moreover, the penalty also varies from bank to bank.

What’s the Difference between Liquid Fund And Fixed Deposit?

The main difference between liquid funds and fixed deposits lies in their nature and returns. Liquid funds are a type of mutual fund that invests in short-term, highly liquid securities, offering potentially higher returns than fixed deposits, particularly in a low-interest rate environment. However, liquid funds do not guarantee returns and can fluctuate based on market conditions. On the other hand, fixed deposits are bank investments with a fixed tenure and guaranteed returns, making them a safer option but with a lower potential for higher yields.

Liquid Funds vs FD

Conclusion

Liquid funds and fixed deposits suit similar kinds of investors, the ones with low-risk tolerance and short-term goals. However, they are completely different from each other. When choosing one among these two, you must consider various factors, including your goals, risk tolerance level, the instrument’s liquidity, and taxation. Remember investing in instruments that suit your requirements and resources can help you achieve all your financial goals.

Frequently Asked Questions

1. Is liquid fund risky?

   Liquid funds are one of the least risky mutual funds. Since they have a very short-term horizon, they are not exposed to interest rate risk. However, there is always a risk of default. Hence you must check the credit rating of underlying securities before investing in liquid funds.

2. Is a liquid fund better than a savings account?

   Yes, liquid funds are better than savings accounts as they offer higher returns than savings accounts. Moreover, liquid funds are equally liquid, and the money can be withdrawn anytime. The only problem with liquid funds is that the returns are taxable, and there is a risk of default, whereas the savings account is risk-free.

3. Is it wise to invest in liquid funds?

   Liquid funds offer higher returns than savings accounts and FDs. They are very liquid and have low risk. Hence, they are considered perfect to park emergency funds. If you want to invest money for short-term goals within three months of the horizon, consider parking the money in liquid funds.

4. Liquid Funds vs FD: Are liquid funds better than FD?

   Liquid funds offer higher returns than fixed deposits. Moreover, they are very liquid and can be withdrawn after seven days of investment without a penalty. Hence liquid funds are a perfect alternative to FDs.

5. Liquid Funds vs FD: Are FD returns better than liquid fund returns?

   No, returns from fixed deposits are slightly lower than liquid funds. Liquid fund returns are in the range of 7%-9%, whereas for FDs, the returns lie in the range of 3%-8%.