September 30, 2024
5 mins read
Ritika started earning a few months ago, and the day she received his first paycheck, she was certain about investing for her major long-term goals: buying a house for her retired parents and taking a dream holiday to Europe. While working towards these goals, a few months later, Ritika realized that the unpredictability of life made it essential to build an emergency fund. She began exploring low-risk options where she could park her surplus funds and access them easily in case of an emergency.
Her parents recommended investing in fixed deposits (FDs), while friends suggested liquid funds as a more suitable option for short-term goals and easy withdrawals. This comparison between liquid funds and fixed deposits left Ritika wondering which path to choose.
If you're also evaluating liquid funds vs fixed deposits, you're in the right place. Read on as we dive into both options and explore the difference between FD and liquid fund, helping you make an informed choice for your financial planning.
To find a better and safer option between FDs and liquid funds, it is first important to understand their meaning and their features. Read on.
Simply put, liquid funds are a kind of mutual funds. Here are some of their key features:
In these debt funds, the investment is done in money market instruments, where returns are generated from underlying money markets and debt instruments, without any assurance, typically through debt or fixed-income instruments
Liquid funds invest in money market instruments with a residual maturity of up to 91 days.
Liquid funds are designed to focus on capital preservation, though they remain subject to market risk. They are generally considered lower-risk compared to other categories of mutual funds, based on their investment profile.
Your fund manager invests the capital in fixed-income securities that come with high credit ratings. Thus, returns tend to be relatively stable due to the short-term nature of the underlying instruments.
Examples include treasury bills, commercial paper, certificates of deposit, and other money market instruments.
Just like mutual funds, the returns from liquid funds are taxable.
Liquid funds are considered to be a safe option, so if you are an investor looking for a place to park your surplus or may be idle cash, then liquid funds are commonly used by investors seeking short-term parking of surplus funds. The returns from liquid funds have historically been higher than savings account interest rates, though this is not guaranteed. So, if you have recently received a bonus or an incentive and want to put it away as an emergency fund, or an upcoming expenses, then liquid funds can be the right choice for you.
Additional Read: Overview of Mutual Fund Categories and Investment Horizons
For most Indians, FDs are one of the most loved way to invest. They are safe, offer flexibility in terms of the tenure and provide a pre-defined interest rate, subject to the issuer’s terms and conditions. Considered to be an ideal way to park extra cash, FDs are an easy to understand financial instrument, and that’s a major reason of its popularity. Some of the main features include:
You open an FD account and deposit a lumpsum amount for a fixed period of time, at a fixed interest rate.
This tenure can range from 7 days to 10 years
At the end of the tenure, you will receive the principal along with the acquired interest
Almost all banks and NBFC offer FD accounts
The FD interest rates vary based on tenure, issuer, and prevailing, keep changing as they are determined by the repo rate, inflation etc
The rate of interest on an FD varies as per the tenure and the company
The interest earned on an FD is taxable. TDS is generally deducted at 10% if interest exceeds the prescribed threshold, or 20% if PAN is not provided.
Breaking the account in the middle of the term comes with a certain charge.
For most traditional or risk-averse investors, an FD is an ideal option. If you are someone who wants to set aside some money and earn some returns on it then you can choose an FD. Your returns will be fixed and you will not have any worry of market fluctuations affecting your investment. FDs are also a good option for an investor who is aggressively invested in other financial instruments. FDs can bring stability to your portfolio.
The table below will help you in an easy FD vs liquid fund analysis. Take a look:
Details | Liquid Funds | Fixed Deposits |
Returns | Returns vary based on market conditions and interest rate environment. | Lower returns |
Ideal for | Short-term liquidity management and temporary surplus parking. | Long term investors |
Investment Risk | Low to moderate risk, subject to interest rate and credit risk as returns are market linked | Low risk, no market investments made |
Taxability | Capital gains are taxed as per applicable income tax rules in force at the time of redemption | TDS is applicable when interest earned goes beyond a certain limit |
Tenure | No fixed lock-in; underlying instruments have maturities of up to 91 days. | 7 days to 10 years |
Here’s hoping that this discussion about liquid funds vs fixed deposit would have brought you some clarity. Both these financial products are considered to be a safe and low-risk option in the investment ecosystem. However, when it comes choosing one between them, it boils down to your needs and expectations as an investor. If you are someone who is okay with low to medium risk, then liquid funds and fixed deposits serve different financial needs depending on liquidity, risk tolerance, and time horizon. However, if capital safety and predictable interest income are the primary considerations, but are looking for a secure way to park some surplus cash, then FDs are the right way forward.
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Liquid funds, also known as money market funds, invest in debt instruments like commercial paper and bonds. With a maturity of 91 days to 3 months, they suit short-term goals for idle cash.
Fixed deposits offer fixed returns on a lumpsum deposit. Here the tenures range from 7 days to 10 years. Long-term investments yield higher returns (5%-7%), but early withdrawals incur penalties and forfeit interest benefits.
As liquid funds are linked to the market, they offer slightly higher returns as compared to FDs.
While liquid funds are considered to be a safer option, they are comparatively riskier than FDs. FDs are not related to the market condition, but in case the market interest rates increase, your existing FD will not benefit.
In case of an FD, TDS is deducted at source if interest earned surpasses ₹40,000 (₹50,000 for seniors) in a financial year. In case of liquid funds, when redeemed within three years, returns are taxed based on your income tax slab. After three years, they're taxed as long-term capital gains at 20%.
As fixed deposits come with an assured return and they are not market-linked, they are considered to be one of the safest options. Liquid funds, though a safe type of mutual carry more risk as compared to FDs.
While both liquid funds and fixed deposit are safe instruments, they are different from each other. In FDs you deposit a lumpsum amount for a fixed tenure, and get a fixed amount once the account matures. In a liquid fund your investments made in low-risk debt funds that are market linked.
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