Liquid Funds vs Savings Account - Which is the Better Investment?

Funds that are liquid in nature operate in a similar way as a savings account. You can easily park your money or withdraw it at your own will, but at the same time, you also enjoy the benefits of higher returns since liquid funds invest in various assets.

While both these investment avenues provide good returns and are low-risk in nature, it is essential to know which of the two—liquid funds vs. savings bank accounts—generates higher returns and is a safer investment choice.

In this article, we will examine both of these options to see which is better.

• Liquid funds generally offer higher returns compared to savings accounts, but they carry some risk due to market fluctuations, unlike the safety of savings accounts.
• While savings accounts offer secure liquidity, investing in liquid funds can diversify your portfolio and balance risk with potential growth, depending on your financial goals.

A savings bank account allows the account holder to deposit money in a safe manner that can be accessed whenever the need arises. You can withdraw money from your savings bank account through your debit card, ATM, cheque, or even UPI. So, many Indians have savings accounts because of the interest the banks give them for depositing money in their bank.

Savings bank accounts allow you to earn interest without having to commit or pledge your deposit, as you do with fixed deposits.

Liquid funds are considered a low-risk category of mutual funds. Their value is based on different market-linked financial instruments, mostly debt instruments. Liquid funds typically invest in short-term assets like treasury bills, commercial papers, CDs or certificates of deposit, and short-term bonds.

Liquid funds generally do not invest in any high-risk shares or commodities. However, they are still exposed to risks like fluctuations in interest rates and the creditworthiness of the investments made by the fund managers, which ultimately affect the returns for investors. Therefore, liquid funds do carry a certain level of risk.

As part of our liquid funds vs. savings account comparison, let us see how these two investment avenues differ from each other on the following parameters:

Rate of interest

If you park your money in a savings account, the rate of interest you will earn can range between 3% and 5% and can go up to as high as 8% for senior citizens.

Liquid funds, on the other hand, provide an interest rate that ranges from 7% to 9%. The exact returns, however, will depend on the fund manager’s allocation and whether they can generate the maximum earnings for the investor.

Treatment of tax

In a savings account, the amount of tax you pay is decided according to the income tax slab you belong to. For example, if you earn more than Rs. 10,000 in a financial year from your savings account, the gains will be considered in your taxable income, and a tax will be levied based on your slab rate.

In the case of liquid funds, you will be subject to capital gains tax on the earnings your fund will generate.

Risk factor

Savings bank accounts are only susceptible to risks that the bank may face if it were to go bankrupt or face any regulatory challenges that can affect operation or withdrawals.

In the case of liquid funds, you are exposed to the risk that the value of your units or market-lined instruments will fall, resulting in less than what you had initially paid for.

It is important to do your due research before opting for any liquid funds, as past performances or recommendations from others are not a good litmus test for future performances. Be aware of your investment goals, risk-taking capacity, and investment horizons before you commit your capital to any specific scheme or fund.

Some basics, like a reputed and trustworthy asset management company with a proven track record, should be non-negotiable and your primary filters. Apart from that, research the fund's paperwork and investment objectives so you can see how they plan to use your capital and whether it matches your preferences.

It is also advisable not to invest all your money in just one liquid fund, as they are market-linked. Hence, one should diversify one's investments across different portfolios to mitigate risk.

Liquid funds can be a lucrative investment for your portfolio, depending on your risk appetite, as they help preserve capital and also generate growth. While savings accounts cannot be replaced, one can invest in a few liquid funds to minimise risk and gain the benefits of a diversified portfolio.