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Fixed Deposit vs Liquid Funds

For investors looking for liquidity along with steady returns, liquid funds could be a great option. However, returns are not guaranteed as in case of fixed deposits. So read on to know which option could be a better choice!

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Fixed deposit has been the favourite investment instrument for many investors. Considering the no-risk factor and guaranteed returns, investors prefer a fixed deposit for short term. Since interest rates on FDs have been on a gradual decline over the past few years, individuals are looking for options where they can park their money and maximize wealth.

This is where liquid funds are considered. Liquid funds, a popular category of mutual funds, provide comparatively higher returns as compared to fixed deposits. These funds are managed by fund managers who diversify the portfolio and reduce the risk. They invest in equity and debt instruments that are consistently performing well.

Fixed deposit is a secured investment scheme offered by banks and financial institutions and serve as one of the easiest investment options for individuals. Interest rates offered on fixed deposits are mostly higher than that of a savings account. A fixed deposit scheme also comes with a fixed investment horizon, making it less liquid. It is considered to be among those investment instruments that have a low-risk component because of its fixed rate of returns.

On the other hand, liquid funds are one of those mutual funds in India which invest in debt instruments. These funds are mostly short-term in nature and can be withdrawn without much hassle. Higher liquidity and scope to earn good returns on investment make liquid funds a beneficial investment avenue.

Liquid Fund Vs Fixed Deposit

Over the last few decades, a slow yet steady shift has been observed in the investment market pertaining to liquid funds. Conservative investors who were primarily more comfortable with the idea of investing their money into fixed deposit are now exploring liquid fund instruments. This shift may be accredited to various factors, which may or may not be directly related to the performance of FDs.

Here are some of the features that distinguish fixed deposit and liquid fund.

Liquidity and lock-in period

In a few words, liquidity in investment can be defined as the level of ease with which your invested money can be withdrawn. When we compare, debt funds tend to have higher liquidity than that of fixed deposit schemes. Investors can avail a quick disbursal of their funds into their personal account within a few working days. A fixed deposit comes with a certain lock-in period. In case the depositor wishes to withdraw their deposit before the maturity, they would have to pay the penalty.

Returns on investment

When it comes to returns on investment, the interest rates on fixed deposit are predetermined by banks and financial institutions based on the term of the deposit. Whereas, in the case of a liquid fund, the rate of return depends on the overall interest rate prevailing in the investment market.

Income tax benefits

Generally, liquid fund investors are considered to be in a better position than fixed deposit holders with regard to taxation on their respective investments. Liquid fund investors are entitled to avail indexation benefit, which directly enables them to lower their tax burden. The long-term capital gains made on liquid funds that were held for over three years are eligible for taxation at the rate of 20% after indexation. While the short-term capital gains made on such investment are taxed in accordance with the individual's tax slab.

In the case of fixed deposit investors, the income earned from FD investment is added to the aggregate income of the investor. The TDS is deducted at the rate of 10% (20% if the PAN is not furnished) by the bank on interest earned on fixed deposit.

Risk factor

Investing in fixed deposit is considered to be almost risk-free. This is exactly why most investors with a conventional investment portfolio prefer to invest in FDs. On the other hand, liquid fund investment is considered to be slightly riskier as they are subject to fluctuating prices and interest rates that influence their Net Asset Value.

However, the NAV of liquid funds does not fluctuate too frequently, owing to their short-term investment horizon. Fixed deposit is a handy way to make sure that you earn that little extra instead of leaving your money in a savings account. Here are some of the features of fixed deposit schemes you should know:

  • The rates of interest are pre-decided by the banks. You know about the returns you will earn on your investment.
  • You need to choose the duration of the fixed deposit before you invest money.
  • Most banks offer FD term ranging from 7 days to 10 years.
  • There may be penalties if you prematurely withdraw money from your fixed deposit account.
  • TDS will be applicable if your interest income exceeds Rs. 40,000 in a particular financial year. This limit is extended to Rs. 50,000 for senior citizen investors. The TDS is deducted at source before paying out any interest due on the fixed deposit. However, in case the TDS rate is lower than your tax slab, you can claim TDS when you file your income tax return.
  • Currently, the best fixed deposit schemes are offering interest rates between 6 to 9% per annum.
  • Interest rates are higher for senior citizen investors.

Liquid mutual funds are an ideal alternative to FDs because they invest in low-risk debt instruments and money market securities. The income earned by the fund is then passed on to the investors in that liquid mutual fund.

Here are some salient features of liquid funds you should know

  • Liquid debt funds come with no lock-in period.
  • The money is invested in money market instruments such as treasury bills, certificate of deposits, term deposits and commercial papers.
  • You can enter and exit the scheme at any point of time.
  • Most of the times, the returns are higher than that of savings and fixed deposit accounts, though they are not guaranteed.
  • Currently, the best liquid funds are providing returns between 8 to 12% per annum.

While liquid fund investment comes with a slew of benefits, they are not entirely immune to risk. As an investor, you should always weigh-in factors such as your risk appetite, time horizon, and future financial goals before investing your hard-earned money. Happy investing!

Recommended Read: Which is a Better Investment Gold or Fixed Deposit?