A liquid fund is a mutual fund scheme that invests in high credit rating companies offering government bonds, deposits and deposits/bonds. Given the short-term debt underlying assets, interest rate volatility decreases. It indicates that their risk profile is quite similar in liquid funds and fixed deposits.
Top liquid funds are considered to be the least risky among the various forms of mutual funds. That is because all investments under these funds are in securities with a credit score of at least P1 +.
In contrast, liquid fund post-tax returns are similar to fixed deposit rates. They change over time, but they persist with each other at the percentage point.
However, it is essential to remember that returns from liquid funds vary daily and do not provide predictions for fixed deposits.
Fixed deposits, such as in the case of tax-saving fixed deposits, can be a lock-in period. If you make a premature withdrawal before the end of the term, then you have to pay the penalty in terms of a reduced fixed deposit rate.
There is no lock-in period for liquid funds, which helps to keep savings closer to cash than fixed deposits.
SEBI allows instant redemption up to a maximum of 50,000, which ensures that the withdrawn amount can be in your savings account within minutes.
It is important to remember that income from the sale of liquid fund units is treated as capital gains for tax purposes.
When you remain invested for more than three years, the long-term capital gains will be treated in the same way and you can reap the benefits of indexation.
If you have a significant capital to invest in and your income falls below the highest income tax threshold, then a Top liquid funds may be a better option.
That is because low tax liabilities can lead to significant savings.
General advice: Keep the required amount in a liquid fund for the next five years and rest in a fixed deposit. It generally recommended that retirees balance the risk and earn a good return.
Liquid funds have better tax treatment than fixed deposits, especially when you fall below the highest tax bracket. Said, forecasting returns and ease of operation can still make FD a better choice for many.
Returns are not assured because fund performance depends on how the market performs in contrast to fixed deposits that are not market dependent. An investor looking for better returns prefers to invest in liquid funds on fixed deposits.
In the group of mutual funds, they are less risky and less volatile, because:
- Mutual funds mainly invest in high-credit rating instruments.
- These instruments are rarely traded on the market due to their short term maturities. They will hold until maturity reached. Therefore, their net asset value only sees a change in the amount of interest earned daily.
Note: An investor can get better returns on liquid funds if he parks his money in a savings account or a fixed deposit.