Liquid Funds vs Fixed Deposits
Liquid funds and Fixed deposits are the two widely opted investment options in India. Both aid people in making great investments. It is important to know more about both fixed deposits and liquid funds if you are someone planning to choose either of these for investment. Here, we will be discussing the features, benefits, risks, and core differences between fixed deposits and liquid funds:
What are Liquid Funds?
Liquid funds are debt mutual funds that invest in short-term money market instruments. They include government bonds, treasury bills, and certificates of deposit. Liquid funds are medium risk and offer a maximum maturity period of 91 days. They do not have entry or exit loads, and the minimum amount needed to invest varies according to each programme. Liquid funds protect the capital and provide short-term capital gains.
What are Fixed Deposits?
Fixed deposits are a more conservative way of investment in India, which is familiar to most people. It is a bank deposit where people can deposit a sum of money for a specific tenure to earn higher interest on the amount. Fixed deposits are long-term and have low risk. Fixed deposits offer a guaranteed return and a lower chance of capital loss. The interest earned depends on the amount and the period of investment. Fixed deposits are considered one of the safest investment options that give long-term yet flexible tenures with stable returns.
Difference Between Liquid Funds and Fixed Deposits
Although similar, liquid funds and fixed deposits have many differences. Listed below are the major differences between both:
Aspect | Liquid Funds | Fixed Deposits (FDs) |
Investment Tenure | Short-term investments, typically ranging from 7 days to 91 days. | Can be invested for 7 days to 10 years. |
Risk Level | Higher risk due to market volatility and economic conditions. | Lower risk as they are offered by banks and NBFCs. |
Returns | Offer higher but non-guaranteed returns. | Offer fixed and guaranteed returns, usually lower than liquid funds. |
Liquidity | High liquidity with lower charges/penalties for early withdrawal. | Premature withdrawal is allowed but usually attracts a penalty of about 1% of the applicable interest rate. |
Taxation | If held for more than 3 years, returns are treated as long-term capital gains (LTCG) and taxed at 20% after indexation. Otherwise, gains are taxed at the investor’s income tax slab rate. | Interest earned is taxed according to the investor’s income tax slab rate under Income from Other Sources. |
Benefits of Liquid Funds
The advantages of liquid funds are as follows:
- These are suitable for short-term investment needs.
- They are a good option for people looking for better returns than traditional savings options.
- They can offer relatively stable and low-risk investment compared to many other market-linked options.
- They allow easy withdrawal of money when needed.
- Premature withdrawals usually have low or minimal penalties, making them flexible and convenient.
Benefits of Fixed Deposits
The benefits of fixed deposit are as given below:
- These are a safe and reliable way for investing money.
- They offer guaranteed returns at a fixed interest rate.
- They are mainly suited for long-term financial goals and regular saving habits.
- The risk involved is very low as compared to most other investments.
- They generally give better interest than a regular savings account.
Who Should Consider Liquid Funds?
- Liquid funds are ideal for investors who want to invest their money for a short period (usually three months) and want to earn higher returns than a regular savings account.
- Investors who are looking for tax-efficient investment options, especially for longer holding periods where favorable capital gains tax treatment may apply.
- They are suitable for individuals who want to redeem money whenever they require it as these funds offer easy redemption with minimal or no penalty after seven days.
- Investors with a low to moderate risk of tolerance can consider liquid funds, as they aim to provide relatively stable returns with less fluctuations.
Who Should Consider Fixed Deposits?
- Fixed deposits are suitable for investors who prioritize capital safety and stable returns over high growth.
- They are an ideal investment option for individuals with a low-risk tolerance who prefer predictable earnings.
- FDs can be a good alternative to savings accounts as they offer higher returns while maintaining a low level of risk.
- Investors who want a secure long-term investment with guaranteed returns may find fixed deposits a suitable choice.
FAQs on Liquid Funds vs Fixed Deposits
- Which is the best investment option? Liquid funds or fixed deposits?
Both liquid funds and fixed deposits have their benefits and drawbacks. It is better to choose either of these according to your needs, funds, and willingness to take risks. If you want a risk-free long-term investment, it would be ideal to pick a fixed deposit. Otherwise, a liquid fund would be a good choice.
- Are liquid funds safe?
Yes, liquid funds are considered quite safe. As they lend to good companies for a very short term, the risks are lower.
- What are the risk factors involved in liquid funds?
The risk factors involved in liquid funds include inflation risk, credit risk, and interest rate risk. It also doesn't provide long-term growth.
- What are the cons of fixed deposits?
Major cons of fixed deposits are their lower returns, fixed interest rates, and penalties on premature withdrawals.
- Is there a minimum and maximum amount limit for fixed deposits?
Generally, the minimum amount one can deposit is Rs.1000 to Rs.10,000. However, it is subject to the bank's policies and may vary. As for the maximum, there is no limitation set.
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