Liquid Funds vs FD (Fixed Deposits): Where to Invest for Better Returns

This post was most recently updated on February 20th, 2024

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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.

Liquid Funds Vs FD - Which one is Better to Invest
Liquid Funds Vs FDs: Which One is Better to Invest

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.

Consider reading: Best Short-Term Investment Plans to Park Money

Liquid Funds vs FD: Comparison

ParameterLiquid FundsFixed Deposits
ReturnsSlightly higherLower
SuitabilityBoth short-term and long-term investorsLong-term investors
Premature withdrawalsYes (with low penalties)Yes (with higher penalties)
TaxationGains added to IncomeDepends on the interest income and tax slab
Ease of investmentOnline through fund houses or platformsOnline or offline through banks or NBFCs
Liquid Funds vs FD Comparison

What are Liquid Funds

Liquid funds, a subset of debt funds, are designed for investors seeking short-term investment avenues with reliable returns. These funds primarily allocate assets to money market instruments like Treasury bills, commercial papers, and high-rated corporate and government bonds. The unique aspect of liquid funds is their investment in instruments maturing within a 91-day window.

Capital Preservation: The Core of Liquid Funds At the heart of liquid funds lies the goal of capital preservation. By focusing on high-rated money market instruments, these funds aim to provide a safety net, making them a relatively safer option compared to other mutual fund categories.

Ideal for Risk-Averse Investors with Short-Term Goals Liquid funds are particularly appealing to risk-averse investors who wish to temporarily allocate surplus cash. Offering higher returns than traditional savings accounts, they serve as a prudent option for managing short-term financial needs, such as parking bonuses, incentives, or proceeds from asset sales.

Key Advantages of Choosing Liquid Funds

  • Rapid Liquidity: One of the standout features of liquid funds is their high liquidity. Investors can redeem their holdings without incurring exit loads or penalties, typically receiving the funds in their bank accounts within 24 hours.
  • Minimized Risk Profile: The investment in high-quality debt instruments with low default risk, coupled with a diversified portfolio approach, minimizes risks. The brief maturity period of these instruments further reduces interest rate and reinvestment risks.
  • Enhanced Returns: When compared to savings accounts or fixed deposits, liquid funds have shown to offer superior returns, particularly in scenarios of declining interest rates. For instance, the average annualized return of liquid funds last year stood at 6.32%, outperforming the average rates of savings accounts (3.5%) and fixed deposits (5.5%).

Liquid Funds vs FD (Fixed Deposits): A Comparative Glance When evaluating liquid funds against fixed deposits, it’s important to consider various factors, including returns, liquidity, and risk. For example, examining the one-year return of a liquid fund offers valuable insights into its performance compared to fixed deposits.

Top 5 Best Performing Liquid Mutual Funds Retunrs in Last 1 Year

Scheme NamePlanCategoryCrisil RankAuM (Cr)YTM1Y Return
Baroda BNP Paribas Liquid Fund – Direct Plan – GrowthDirect PlanLiquid Fund410,252.637.06%5.59%
UTI Liquid Cash Plan – Direct Plan – GrowthDirect PlanLiquid Fund328,679.096.85%5.56%
Franklin India Liquid Fund – Super Institutional – Direct – GrowthDirect PlanLiquid Fund51,842.016.93%5.50%
Canara Robeco Liquid Fund – Direct Plan – GrowthDirect PlanLiquid Fund43,230.487.00%5.51%
Bank of India Liquid Fund – Direct Plan – GrowthDirect PlanLiquid Fund41,117.636.98%5.58%
Toop 5 Best Performing Liquid Mutual Funds in Last 1 Year

Consider reading: Best Mutual Funds for SIP

What are Fixed Deposits

Fixed deposits (FDs) are a favored investment choice for individuals seeking stable returns without exposure to market risks. Offered by banks and non-banking financial companies (NBFCs), FDs allow investors to deposit a lump sum over a set period, typically yielding higher interest than regular savings accounts.

Stability and Predictability: Core Features of Fixed Deposits A key characteristic of FDs is the fixed interest rate, established at the outset and maintained throughout the investment’s tenure. Investors have the flexibility to receive interest payouts periodically or as a lump sum upon maturity, enabling effective financial planning.

Ideal for Risk-Averse Investors Seeking Guaranteed Returns FDs cater to those preferring no risk in their investment journey, assuring a predetermined return. Governed by the Reserve Bank of India, bank-offered FDs come with an insurance cover up to Rs. 5 lakh per account, providing a safety net for both the principal and interest.

Due Diligence for NBFC Fixed Deposits When considering FDs from NBFCs, it’s crucial to assess their stability, for instance, by examining CRISIL ratings. This ensures the safety of your investment, particularly for long-term financial planning.

Advantages of Investing in Fixed Deposits

  • Assured Yields: FDs offer fixed returns, set by the Reserve Bank of India in response to economic and financial conditions. This clarity allows investors to precisely calculate their earnings by the end of the investment period.
  • High-Safety Quotient: With the backing of banks or NBFCs and an insurance cover up to Rs. 5 lakh, FDs stand as extremely low-risk investments. Investors remain insulated from market volatility and default risks.
  • Adaptable Investment Options: FDs provide varied tenure choices, from 7 days to 10 years, catering to diverse financial objectives and liquidity needs. Investors can select cumulative or non-cumulative interest payouts and have the freedom to reinvest or withdraw the maturity amount.

Comparing Fixed Deposits and Liquid Funds While analyzing the investment landscape, it’s informative to juxtapose FD returns against those of liquid funds. For instance, evaluating the one-year return of fixed deposits offers insights into their performance relative to liquid funds.

Best FD Rates Available for 1 Year Fixed Deposits

Bank NameInterest Rate (p.a.)Minimum Deposit Amount
DBS Bank7.50%Rs. 10,000
IDFC First Bank7.50%Rs. 10,000
IndusInd Bank7.50%Rs. 10,000
Bandhan Bank7.25%Rs. 1,000
HDFC Bank7.25%Rs. 5,000
Best FD Rates Available for 1-Year Fixed Deposits

Consider reading: Types of Mutual Funds Available in India

Taxation on Liquid Funds Vs FD

Understanding the tax treatment of investment options like liquid funds and fixed deposits is crucial for effective financial planning. Taxation varies based on the investment’s holding period and the investor’s income.

Taxation of Liquid Funds: Income Integration Income earned from liquid funds is integrated into the investor’s total income for tax purposes. This means that the returns from liquid funds are taxed according to the investor’s applicable income tax slab, which can vary based on their overall annual income.

Fixed Deposits: Interest Income Taxation In the case of fixed deposits, the interest income is taxed according to the investor’s tax slab, regardless of the holding period. Tax Deducted at Source (TDS) is applicable as follows:

  • A 10% TDS is deducted by banks or NBFCs if the interest income exceeds Rs. 40,000 in a financial year.
  • For senior citizens, this threshold is higher, at Rs. 50,000.
  • Investors must declare this interest income in their tax returns and pay any additional tax due.

Informed Tax Planning for Investments It’s essential for investors to understand these tax norms as they can significantly impact the net returns from their investments in liquid funds and fixed deposits. Proper awareness aids in making more informed investment decisions, ensuring that one’s financial strategies are aligned with tax obligations.

Consider reading: What are Arbitrage Funds and their meaning

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

Fixed deposits (FDs) represent a cornerstone in conservative investment strategies, appealing to a wide range of investors for several compelling reasons:

Guaranteed Returns: A Pillar of Fixed Deposits The hallmark of FDs is their promise of guaranteed returns. Unlike market-linked investments, FDs offer a fixed rate of return, established at the outset of the investment. This feature allows investors to precisely calculate their expected earnings, providing clarity and predictability in financial planning.

Ideal for Investors with a Low Risk Appetite FDs are synonymous with safety. Backed by banks or NBFCs, they come with insurance coverage of up to Rs. 5 lakh per account, safeguarding the principal and interest. This insulation from market volatility and default risks makes FDs an attractive option for those averse to taking financial risks.

Well-Suited for Long-Term Financial Goals For investors with a long-term perspective, FDs are particularly suitable. These instruments are designed for longer investment horizons, offering higher interest rates for extended tenures. This makes them an excellent choice for those who can afford to lock in their funds for prolonged periods, maximizing the potential for higher returns.

A Reliable Component in Diverse Investment Portfolios Incorporating fixed deposits into an investment portfolio can provide balance and stability, complementing more volatile investment options. By allocating a portion of funds to FDs, investors can achieve a diversified portfolio, catering to both immediate and long-term financial objectives.

Use Our XIRR Calculator to check how much real return you are making on your investments.

Why Should Someone Invest in Liquid Funds

Liquid funds emerge as a compelling investment option for certain investors due to their distinctive features:

Superior Returns Compared to Savings and Fixed Deposits A primary advantage of liquid funds is their potential to offer higher returns than traditional savings accounts and fixed deposits, particularly in environments where interest rates are declining. These funds are managed by professionals who allocate assets to high-quality debt instruments. The focus on instruments with low default or downgrade risk ensures a stable and potentially higher yield.

Ideal for Short-Term Investment Goals Liquid funds are tailor-made for investors with short-term financial objectives. They offer a high degree of liquidity, allowing investors to redeem their units at any time without incurring exit loads or penalties. This feature is particularly advantageous for those who need quick access to their funds. Typically, the redemption process is swift, with fund houses usually transferring the amount to the investor’s bank account within 24 hours.

A Prudent Choice for Managing Short-Term Finances These funds are suitable for individuals looking to park their funds temporarily, perhaps in anticipation of upcoming expenses or as a holding strategy until deciding on longer-term investments. The combination of higher returns and quick liquidity makes liquid funds an attractive option for managing short-term financial needs efficiently.

Liquid Funds vs FD: Final Verdict

Investors often grapple with the choice between liquid funds and fixed deposits, as both offer unique advantages. Your decision should hinge on several key factors, including risk tolerance, expected returns, investment duration, liquidity needs, and tax considerations.

Fixed Deposits: The Go-To for Stability and Long-Term Goals If you prioritize security and guaranteed returns, and if you’re planning for long-term financial goals without the need for immediate liquidity, fixed deposits could be your ideal choice. Suited for individuals with a low risk appetite, FDs offer predictable returns and are a staple in conservative investment portfolios.

Liquid Funds: Catering to Short-Term Goals with Higher Returns On the other hand, if your investment horizon is shorter and you’re seeking returns that potentially outperform savings accounts and FDs, liquid funds may align with your requirements. These are suitable for investors with a moderate risk tolerance, providing flexibility and quick access to funds, which is ideal for short-term financial planning.

Diversification: Blending Stability with Flexibility A strategic approach could involve diversifying your investment portfolio by allocating funds to both liquid funds and fixed deposits. This diversification allows you to benefit from the stability and guaranteed returns of FDs while taking advantage of the higher returns and liquidity offered by liquid funds.

We hope this blog post has equipped you with a clearer understanding of liquid funds and fixed deposits, helping you to make an investment choice that best suits your financial objectives and comfort with risk.

Consider reading: Index Funds Vs ETF

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.

Which is better RD or liquid fund?

Liquid funds generally offer better liquidity and no penalty on withdrawal compared to Recurring Deposits (RD). They also have the potential for higher returns, but with greater market risk. RDs provide fixed returns and are subject to tax on interest. Choose based on your risk tolerance and liquidity needs.

Which fund is better than FD?

Determining a better fund between FDs (Fixed Deposits) and mutual funds hinges on your risk tolerance. FDs offer safety and steady, predictable returns, ideal for conservative investors. Contrarily, mutual funds provide the opportunity for higher returns dependent on market performance, suitable for those willing to accept more risk for potential gains.

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