Liquid Funds vs FD: Finding the Right Fit for Your Portfolio

In the landscape of Indian investments, fixed deposits have stood the test of time as a safe and trustworthy option. Before the advent of shares and mutual funds, fixed deposits held sway, offering stability and dependable returns. They boasted merits like low risk, reasonable gains, and easy liquidity.

As years rolled on, the financial arena expanded, giving rise to diverse fund types catering to various investor profiles. Notably, for those favouring fixed deposits, liquid funds emerged as an intriguing contender. These funds share a risk profile similar to fixed deposits, prompting many investors to draw comparisons.

Prior to embarking on an investment journey, it’s important to grasp the intricacies of both instruments.

What Are Liquid Funds?

Liquid funds direct investment into debt or fixed-income instruments like commercial paper, bonds, treasury bills, and government securities. Fund managers handle these investments on behalf of participants, often referred to as money market funds. With maturity periods spanning 91 days to 3 months, liquid funds suit individuals with short-term cash to spare. They align with goals requiring quick financial action.

An attractive feature is the absence of a lock-in period. This translates to the freedom to redeem mutual fund units at your convenience. As liquid funds invest in high credit-rated fixed-income securities, the associated risks and gains remain relatively stable. Scrutinizing the credit ratings of underlying securities aids in gauging risk. Remember, tax on short-term and long-term capital gains applies upon redemption.

What Are Fixed Deposits?

Fixed deposits step in when you possess a substantial sum and seek fixed returns. You can select deposit tenures from 7 days to 10 years. Short-term FDs deliver returns akin to savings accounts, while prolonged investments yield higher returns. Interest rates range from 5% to 7%. Deposits remain locked for the chosen tenure, allowing withdrawal in emergencies at a penalty.

While flexibility exists, withdrawing before maturity forfeits interest benefits. This makes FDs less suitable for creating an emergency fund. Interest rates hinge on factors like the repo rate and inflation rate. Tax applies to interest earned, subject to TDS deduction. TDS rates vary based on PAN card submission, offering tax-saving potential through form 15G/H submission or claiming refunds via ITR.

Learn more : What is a Fixed Deposit Account?

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Difference Between Liquid Fund and Fixed Deposit

Parameters Liquid Funds Fixed Deposits (FD)
Rate of Returns Liquid funds generally offer potentially higher returns compared to fixed deposits. However, returns are subject to market fluctuations and are not guaranteed. FDs provide a fixed rate of return, which is usually lower than liquid funds, but it offers assured and predictable earnings.
Premature Withdrawal Liquid funds usually have a minimal penalty if redeemed within a short period, often within seven days. FDs typically have a higher penalty for premature withdrawal before the maturity date.
Minimum Investment Investors can start with relatively low amounts, usually around ₹1000 for liquid funds. Some asset management companies may set a cap of ₹5000. FDs allow investors to begin with a minimum investment as low as ₹100.
Investor Profile Liquid funds are suitable for investors with a low to medium risk appetite and are suitable for both short-term and long-term financial goals. FDs are more appropriate for investors with a conservative risk appetite, seeking stability, and relevant for both short-term and long-term investment objectives.
Investment Horizon Liquid funds invest in securities with a maturity of up to 91 days, making them ideal for short-term investments. FDs have a fixed tenure that can range from 7 days to 20 years, catering to both short-term and long-term investment needs.
Tax Implications For liquid funds, returns redeemed after three years are taxed as long-term capital gains at a rate of 20%. Tax Deducted at Source (TDS) is not applicable for liquid funds. If redeemed before three years, the returns are taxed based on the investor’s income slab rate. For FDs, the interest is added to the investor’s annual income and taxed as per the applicable income tax slab. TDS at a rate of 10% is applicable on interest income if it exceeds specified limits. Additionally, five-year tax-saving FDs offer a tax deduction of up to ₹1.5 lakh under Section 80C of the Income Tax Act of 1961./td>
Tenure 7 Days to 91 Days 1 Week to 10 Years
Minimum Investments Requires a low investment amount Requires a high investment amount


Things To Consider Before Investing in a Fixed Deposit

  • Economic Condition: Economic prosperity and GDP growth often correspond to higher FD rates.
  • Monetary Policy: The central bank’s repo rate changes impact FD interest rates, necessitating consideration.
  • Inflation Rate: Inflation prompts rate hikes to encourage saving and vice versa.

To know more, check out our detailed blog post on: Does Fixed Deposit Interest Rate Change?

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Things To Consider Before Investing in Liquid Funds

  • Investment Horizon: The timeline of investment determines the suitability of liquid funds.
  • Fees and Expenses: Management fees, expense ratio, and transaction costs impact returns.
  • Liquidity Risk: Selling investments quickly without loss is a key concern.
  • Returns: While liquid funds offer better returns than FDs, guaranteed rates aren’t assured.

Final Thoughts

When it comes to settling liquid funds vs FD, it ultimately depends on your financial goals and risk tolerance. Liquid funds offer higher returns in the short term, with the added benefit of liquidity, making them a suitable option for emergency funds or short-term goals. On the other hand, fixed deposits provide stability and guaranteed returns over a longer period of time, making them ideal for long-term savings or retirement planning. It is important to carefully assess your financial needs and consult with a financial advisor before making any investment decisions. So, take some time to evaluate your portfolio and determine which option aligns best with your goals.