Liquid Funds vs FD: Where to Invest for Better Returns?
If you are someone who is looking to park lump sum money for a short time and wondering which is the best short-term investment option in Liquid Funds vs FD then you have come to the right place.
In this blog post, I will compare liquid funds and fixed deposits, two of the most popular investment options that are considered to be safe.
I will use the latest data from 2023 for comparison. I will also share my first-hand knowledge and experience with these instruments. I hope you find this blog post useful and informative.
Consider reading: Best Short-Term Investment Plans to Park Money
Page Contents
Liquid Funds vs FD: Comparison
| Parameter | Liquid Funds | Fixed Deposits |
|---|---|---|
| Returns | Slightly higher | Lower |
| Suitability | Both short-term and long-term investors | Long-term investors |
| Risk | Medium | Low |
| Premature withdrawals | Yes (with low penalties) | Yes (with higher penalties) |
| Taxation | Gains added to Income | Depends on the interest income and tax slab |
| Ease of investment | Online through fund houses or platforms | Online or offline through banks or NBFCs |
What are Liquid Funds?
Liquid funds are a class of debt funds that invest in short-term assured interest-providing money market instruments such as Treasury bills, commercial papers, and high-rated corporate and government bonds. The instruments in which liquid funds invest mature within a timeframe of ninety-one days.
The main objective of liquid funds is to provide safety in the form of capital preservation. It is for this reason that these funds invest in high-rated money market instruments. Hence, liquid funds are considered to be relatively safer than any other class of mutual funds.
Liquid funds are suitable for investors who are risk-averse and looking to park their idle or surplus cash for a short period of time. These funds are an excellent option when compared to a regular savings bank account as liquid funds offer much higher returns than the latter.
One may consider investing their incentives, bonuses, or any other gains that have resulted from selling the securities or assets that they hold.
Some of the benefits of investing in liquid funds are:
- High liquidity: Liquid funds can be redeemed at any time without paying any exit load or penalty. The redemption process is usually quick and hassle-free. The fund houses usually credit the amount to the investor’s bank account within 24 hours.
- Low risk: Liquid funds invest in high-quality debt instruments that have a low probability of default or downgrade. The fund managers also maintain a diversified portfolio to reduce concentration risk. The short maturity period of the instruments also reduces the interest rate risk and the reinvestment risk.
- Better returns: Liquid funds offer better returns than savings accounts and fixed deposits, especially in a falling interest rate scenario. The average annualized return of liquid funds in the last year was 6.32%, while the average interest rate of savings accounts was 3.5% and fixed deposits were 5.5%.
While doing a comparison between Liquid Funds vs FD, let’s consider the Liquid Fund return in last 1 Year.
Toop 5 Best Performing Liquid Mutual Funds in Last 1 Year
| Scheme Name | Plan | Category | Crisil Rank | AuM (Cr) | YTM | 1Y Return |
|---|---|---|---|---|---|---|
| Baroda BNP Paribas Liquid Fund – Direct Plan – Growth | Direct Plan | Liquid Fund | 4 | 10,252.63 | 7.06% | 5.59% |
| UTI Liquid Cash Plan – Direct Plan – Growth | Direct Plan | Liquid Fund | 3 | 28,679.09 | 6.85% | 5.56% |
| Franklin India Liquid Fund – Super Institutional – Direct – Growth | Direct Plan | Liquid Fund | 5 | 1,842.01 | 6.93% | 5.50% |
| Canara Robeco Liquid Fund – Direct Plan – Growth | Direct Plan | Liquid Fund | 4 | 3,230.48 | 7.00% | 5.51% |
| Bank of India Liquid Fund – Direct Plan – Growth | Direct Plan | Liquid Fund | 4 | 1,117.63 | 6.98% | 5.58% |
Consider reading: Best Mutual Funds for SIP
What are Fixed Deposits?
Fixed deposits are a popular form of bank deposit where individuals deposit a lump sum over a fixed period of time to earn a higher interest than what regular savings accounts provide.
Fixed deposits are offered by banks and non-banking financial companies (NBFCs). The interest rate is fixed at the time of investment and does not change during the tenure of the deposit. The investor can choose to receive interest on a periodic basis or receive the interest accrued at the end of the tenure of the fixed deposit.
Fixed deposits are suitable for those who are not ready to bear any risk with their investments and want a guaranteed return on their capital. As fixed deposits are offered by banks, they are always under the purview of the Reserve Bank of India and usually have an insurance policy protecting the invested capital and interest up to Rs.5 lakh per bank account.
However, if one is investing in fixed deposits offered by an NBFC, then it is essential to check ratings such as CRISIL rating to ensure that they are safe. Investing in fixed deposits is an excellent option if one is looking for long-term investment options.
Some of the benefits of investing in fixed deposits are:
- Assured returns: Fixed deposits offer a fixed rate of return that is governed by the Reserve Bank of India based on the condition of the economy and the financial system in the country. The investor knows exactly how much interest he/she will earn at the end of the tenure and can plan accordingly.
- Safety: Fixed deposits are considered to be extremely-low risk investments since they are backed by banks or NBFCs and have an insurance cover up to Rs.5 lakh per bank account. The investor does not have to worry about market fluctuations or default risk affecting his/her investment.
- Flexibility: Fixed deposits offer flexibility in terms of choosing the tenure, frequency of interest payout, and reinvestment options. The investor can choose from various tenures ranging from 7 days to 10 years, depending on his/her financial goals and liquidity needs. The investor can also opt for cumulative or non-cumulative interest payout, depending on his/her income requirement. The investor can also reinvest the maturity amount or withdraw it as per his/her convenience.
While doing a comparison between Liquid Funds vs FD, let’s consider the Fixed Deposit return in last 1 Year.
Best FD Rates Available for 1 Year Fixed Deposits
| Bank Name | Interest Rate (p.a.) | Minimum Deposit Amount |
|---|---|---|
| DBS Bank | 7.50% | Rs. 10,000 |
| IDFC First Bank | 7.50% | Rs. 10,000 |
| IndusInd Bank | 7.50% | Rs. 10,000 |
| Bandhan Bank | 7.25% | Rs. 1,000 |
| HDFC Bank | 7.25% | Rs. 5,000 |
Consider reading: Types of Mutual Funds Available in India
Taxation on Liquid Funds Vs FD
The taxation of liquid funds and fixed deposits depends on the holding period and the interest income of the investor.
- Liquid funds: The income from Liquid funds are added to the total income of the investor for calculating tax.
- Fixed deposits: The interest income from fixed deposits is taxed as per the investor’s tax slab, irrespective of the holding period. The bank or NBFC deducts tax deducted at source (TDS) at 10% if the interest income exceeds Rs.40,000 in a financial year (Rs.50,000 for senior citizens). The investor has to declare the interest income in his/her income tax return and pay tax accordingly.
Ease of Investment Between Liquid Funds Vs FD
The ease of investment between liquid funds vs FD depends on the mode of investment and the documentation required.
- Liquid funds: The investor can invest in liquid funds online through fund houses or platforms that offer direct plans. The investor has to complete the know-your-customer (KYC) process and provide bank details, PAN card, and Aadhaar card. The investor can also set up a systematic investment plan (SIP) or a systematic withdrawal plan (SWP) to automate his/her investments or withdrawals.
- Fixed deposits: The investor can invest in fixed deposits online or offline through banks or NBFCs. The investor has to provide bank details, PAN card, and Aadhaar card. The investor can also choose to renew his/her fixed deposit automatically or manually at the end of the tenure.
Thinking of Starting a SIP? Use our SIP Calculator to check how much you can earn from SIP investments.
Why Should Someone Invest in FD
Someone should invest in fixed deposits if he/she:
- Wants a guaranteed return on his/her investment: Fixed deposits offer a fixed rate of return that does not change during the tenure of the deposit. The investor can estimate the exact returns from his/her investment at the time of investment.
- Has a low risk appetite: Fixed deposits are extremely-low risk investments that are backed by banks or NBFCs and have an insurance cover up to Rs.5 lakh per bank account. The investor does not have to worry about market fluctuations or default risk affecting his/her investment.
- Has a long-term investment horizon: Fixed deposits are suitable for long-term investors who do not need liquidity in the short term. The longer the tenure of the deposit, the higher is the interest rate offered by the bank or NBFC.
Use Our XIRR Calculator check how much real return you are making on your investments.
Why Should Someone Invest in Liquid Funds
Someone should invest in liquid funds if he/she:
- Wants higher returns than savings accounts and fixed deposits: Liquid funds offer higher returns than savings accounts and fixed deposits, especially in a falling interest rate scenario. The fund managers invest in high-quality debt instruments that have a low probability of default or downgrade and offer assured interest income.
- Has a short-term investment horizon: Liquid funds are suitable for short-term investors who need liquidity in the short term. The investor can redeem his/her units any time without paying any exit load or penalty. The fund houses usually credit the amount to the investor’s bank account within 24 hours.
Liquid Funds vs FD: Final Verdict
Both liquid funds and fixed deposits are safe investment options that offer different benefits to different investors. The choice between them depends on various factors such as risk appetite, return expectation, investment horizon, liquidity requirement, and tax implications.
If you are looking for a guaranteed return on your investment, have a low-risk appetite, and have a long-term investment horizon, you may consider investing in fixed deposits.
If you are looking for higher returns than savings accounts and fixed deposits, have a medium-risk appetite, and have a short-term investment horizon, you may consider investing in liquid funds.
You may also diversify your portfolio by investing in both liquid funds and fixed deposits to enjoy the best of both worlds.
I hope this blog post has helped you understand the difference between liquid funds and fixed deposits and make an informed decision.
FAQs on Liquid Funds vs FD
Which is better FD or liquid fund?
When comparing fixed deposits (FDs) and liquid funds, it’s important to note that liquid funds do not offer guaranteed returns. However, they generally provide better returns than FDs. It’s crucial to ensure that the fund manager doesn’t take excessive risks while managing the fund’s portfolio. Before investing, carefully review the offer document for further details.
Are liquid funds safer than FD?
Yes, liquid funds are safer than FDs. With liquid funds, investors enjoy greater safety and security due to their lower-risk nature. Additionally, liquid funds provide a higher rate of return compared to fixed deposits, making them an attractive choice for investors seeking safer investment options. Choose liquid funds to benefit from both safety and potential returns.
Are FD returns better than liquid fund returns?
No, FD returns are not better than liquid fund returns. Liquid funds invest in money market instruments and offer predictable returns, usually in the range of 7-9%, which are higher than FDs and savings accounts. So, if you are looking for higher returns, liquid funds are a better investment option than fixed deposits.
What are the disadvantages of liquid funds?
The main disadvantage of liquid funds is that their returns are not guaranteed. While liquid funds offer superior returns compared to bank deposits, they are still subject to market fluctuations. This makes them unsuitable for investors seeking a fixed and predictable income. Therefore, it is important for investors to understand the potential risks associated with liquid funds before investing.
