Liquid Funds Vs Fixed Deposits: What Are the Differences Between Them?

Liquid Funds Vs Fixed Deposits: An Overview

Fixed deposit is the most trustable and most popular investment option among Indian investors as they provide fixed returns. Whereas liquid funds are best suitable for investors having a short-term investment horizon. You can choose to invest in liquid funds if you have a low-risk appetite and want to get better returns than fixed deposits. However, it is important to understand what are liquid funds and fixed deposits before making any investment decision. In this article, we are going to learn about liquid funds vs FD, what are liquid funds and fixed deposits, benefits of liquid funds and fixed deposit and top liquid funds and fixed deposits. 

What Are Liquid Funds?

Liquid funds invest in debt or fixed-income instruments such as commercial paper, bonds, treasury bills, and government securities. The fund manager invests in these securities on the behalf of their investors. They are also known as money market funds. The maturity period of liquid funds ranges from 91 days to 3 months. It is suitable for those who have idle cash and don't need the funds for 2 to 3 months. Investing in liquid funds helps you to meet short-term goals. 

Liquid funds do not have a lock-in period and hence, you can redeem your mutual fund's units whenever you want to. Since they invest in fixed-income securities with high credit ratings, they do not experience any major losses or gains. Make sure to check the credit ratings of the underlying securities to analyze the risk associated with them. One thing you need to keep in mind is that you have to give tax on short-term capital gain and long-term capital gain whenever you redeem your mutual fund units. 

What Are Fixed Deposits?

Fixed deposits can be done when you have a considerable sum of money and want to earn fixed returns. The tenure of fixed deposits can be chosen from 7 days to 10 years. However, the returns on short-term investment in FDs are similar to savings accounts. If you want to earn higher returns you need to invest for the long term. The interest rate on fixed deposits ranges from 5 to 7%. You have the option to choose the tenure of your fixed deposits and your investment will be locked in for that chosen period. And in case of any emergency, you need the funds, and you have the option to withdraw your money but you have to pay the penalty. However, you don't get any interest benefits if you withdraw your money before maturity and this is the reason it is not suitable for creating an emergency fund. 

The interest rate on fixed deposits is determined by various factors such as repo rate, inflation rate, etc. however, the interest earned on fixed deposits is taxable and is subject to TDS deduction. If the interest earned on the fixed deposit is more than Rs. 40,000 then you have to pay TDS at 10% (If you have provided your PAN card details) and in case you have not provided then you will pay TDS at 20%. If you are a senior citizen, you will be charged TDS at 10% if the returns earned on FD are more than Rs. 50,000.you can prevent paying TDS to the bank if you submit form 15G/H if you do not come under the taxable income bracket. Even if you fail to do so, you can claim a refund while filing ITR (Income tax return).

Most Common Types of Fixed Deposits

Cumulative fixed deposit: The interest on cumulative fixed deposit is calculated at the time of the end of the tenure and is given to the depositor at the maturity date. The interest earned each year on FD is reinvested back as per current FD rates. The interest rate of cumulative fixed deposits is better than non-cumulative fixed deposits. It is suitable for those who have a regular source of income. 

Non-Cumulative fixed deposit: The interest earned on a fixed deposit is paid to the depositor monthly/quarterly/ semi-annually or annually. Hence, the payment of interest is done regularly. It is suitable for those who are retired or have unstable income and can invest in non-cumulative FD to earn regular income.

Benefits of Fixed Deposits

Fixed deposits offer several benefits that can make them an attractive option for investors. Here's a look at some of the key benefits:

1. Fixed deposit rates are known for providing typically stable returns, providing investors with stability and certainty when making investment decisions.
2. Fixed deposits offer protection against inflation, as the interest rates paid on these products are usually fixed and not affected by inflation.
3. Withdrawals can be made at any time. However, you have to pay the penalty. 
4. Fixed deposits provide a higher return than other savings accounts. 
5. Investing in fixed deposits can be a good investment option to diversify your portfolio. 
6. You can avail of loan benefits against your FD. However, the conditions can differ from bank to bank.

So if you're looking for a safe and reliable investment option, fixed deposits may be the right choice.

Benefits of Liquid Funds

1. Liquid funds offer several advantages over fixed deposits. For example, liquid funds are easy to access and move around, making them ideal for short-term needs.
2. Liquid funds are typically cheaper than fixed deposits and they do not have an entry or exit load. 
3. Liquid funds offer a higher rate of return than fixed deposits, which can make them a better choice for investors who are looking for a higher return on their investment.
4. Liquid funds are also less risky than fixed deposits as they offer greater safety and security.
5. Liquid funds offer flexible withdrawal options as they have no lock-in period, making them a more convenient option for borrowers and savers. You can allocate your emergency funds in liquid funds as it allows you to withdraw your money any time you want to.
6. Liquid funds offer capital gains and dividends.
7. Investing in fixed deposits can be a good investment option to diversify your portfolio. 

Liquid Funds Vs Fixed Deposits: Which Is Better?

1. Fixed deposits are offered by banks, NBFCs, and post offices and are low-risk investment options. Moreover, depositors have insured up to Rs. 5 lakh on their principal and interest amounts. On the other hand, liquid funds invest in debt instruments such as government and corporate bonds. However, they are affected by volatility in the stock market and economic conditions. So, liquid funds are comparatively riskier than fixed deposits. 
2. Fixed deposits offer fixed rates of interest and it is governed by the central bank of India. The interest rates of fixed deposits are determined by various factors such as monetary policy, economic conditions, and the financial system of India. The returns offered by fixed deposits are higher than savings accounts and lower than liquid funds. Unlike fixed deposits, liquid funds do not offer fixed rates of interest. But they offer more returns than FD. The fund managers do not take high risks and aim to provide stable returns. 
3. Fixed deposits have a maturity date that is decided by the depositor and the rate of interest on the invested amount is determined by the tenure of the deposit. However, you can withdraw your money before the maturity date but you have to pay the penalty and this penalty is around 1% of the applicable interest. On the other hand, liquid funds can be redeemed at any time without paying any penalty or charges. One thing you need to keep in mind is that the exit load is charged on liquid funds if you redeem your units within 7 days of buying them. For example, you invest in a liquid fund and opt to redeem the units after 2 days. Then you will be charged the exit load. After the 7th day, there will be no charges levied on the exit of liquid funds. Hence, they offer better liquidity than FD. 
4. In terms of investment horizon, the tenure of fixed deposits ranges from 7 to 10 years while the tenure of liquid funds is up to 91 days.
5. The interest earned on fixed deposit investment is taxable. If the returns earned exceed more than Rs. 40,000 then the bank will deduct TDS at 10%. To avoid paying TDS, you can spread your FD in multiple accounts or can invest in tax-saving fixed deposits. Tax saving FD gives you tax benefits of up to Rs. 1.5 lakhs U/S 80C of the Income tax act. On the other hand, you have to pay long-term capital gains tax at 20% if you stay invested in the liquid funds for more than 3 years and if you stay invested in a liquid mutual fund for less than 3 years, the interest is taxed as per the income tax slab. 

Things To Consider Before Investing in a Fixed Deposit

• Economic condition: The economic condition of the country plays a major role in influencing the FD rates. When the economy is prospering and GDP is increasing, the FD rate is also likely to increase.
• Monetary policy: The central bank of India is the authoritative body for the entire banking system. They increase or decrease the repo rate based on the inflation rate. When the repo rate changes, the fixed deposit interest rates are also changed. So, you need to consider the repo rate before investing in a fixed deposit. 
• Inflation rate: Inflation is when the cost of goods and services increases. The RBI is responsible for tackling inflation in the country. When the inflation rate is high, they will hike the interest rate on FD so that people could save more rather than spend. On the other hand, when inflation decreases, they lower the interest rate on FD so that they can spend more rather than saving. 

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Things To Consider Before Investing in a Liquid Fund

• Investment horizon: It is important to consider the timeline of your investment or how long you are willing to invest before investing in a liquid fund. 
• Fees and expenses: You should check management fees, expense ratio and transaction costs as these expenses can reduce your returns over time. Also, make sure to compare the returns of different liquid funds to make informed decisions. Also, you need to check the tax implications. 
• Liquidity risk: Liquidity risk is the risk associated with being able to sell an investment at any time or within a short time frame. Liquidity risk can impact investors because they may not have enough time to react if they need money urgently for some reason. 
• Returns: liquid funds provide better returns than FD but they do not guarantee that they will provide a certain rate of return. However, liquid funds have given positive yield returns in the past.

Best Liquid Funds in India

(Data as of 30 November 2022)
Disclaimer: The securities quoted are exemplary and not recommendatory. Past performance is not indicative of future returns

Best Fixed Deposits in India

(Data as of 30 November 2022)

Disclaimer: The securities quoted are exemplary and not recommendatory. Past performance is not indicative of future returns

Conclusion

If you're looking to invest in a long-term financial product, a fixed deposit may be a better option for you. A fixed deposit is a savings account that pays a fixed interest rate of return on your investment. Since fixed deposits are not linked to the stock market, your earnings remain the same regardless of the market environment.

On the other hand, if you're looking for short-term financial stability, liquid funds may be more suitable. Liquid funds are invested in fixed-income instruments such as corporate and government bonds. It can be quickly and easily converted into cash. This makes them ideal for short-term needs like paying rent or buying groceries. 

No matter where you invest, it is important to consider your investment objective, the timeline of your investment, and the ability to take risks before investing in any financial instruments. 

This is not an investment advisory. The blog is for information purposes only. Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements, risk tolerance, goal, time frame, risk and reward balance, and the cost associated with the investment before choosing a fund, or designing a portfolio that suits your needs. The performance and returns of any investment portfolio can neither be predicted nor guaranteed.