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FD vs liquid funds: Which investment is right for you?

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Published Date: 26 Nov 2024Updated Date: 30 Dec 20246 mins readBy MOFSL

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Introduction

A good portfolio combines everything to meet distinct financial goals while diversifying your investments. A part of this mix is safe investments. If you are considering your options for this category, Fixed Deposits (FDs) and Liquid Funds stand out. Both offer stability and bear a similar risk profile, but they are not the same. They differ in terms of liquidity, risk, tax benefits, and more. It is important to understand these differences to make the right pick. In this guide, we will dive into the details of FD vs Liquid Fund to help you make the best selection.

FD vs Liquid Fund: Understanding the meaning

A Fixed Deposit or FD is a traditional savings term deposit account where you deposit a lump sum with a bank for a specified period. In return, you earn a fixed interest rate. FDs are known for their low risk and stable returns, which makes them an apt choice if you are a conservative investor. Banks offer various tenures for FDs, ranging from a few days to several years. This makes them flexible enough to meet multiple financial needs.

Liquid funds are a type of debt mutual fund that primarily invests in short-term money market instruments. They include treasury bills, government securities, and deposit certificates. With an average maturity of less than 91 days, liquid funds give you quick access to cash while offering more attractive returns than traditional saving accounts. They are a good option if you seek liquidity and slightly better returns without taking too much risk.

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Comparing Liquid Funds vs FD: Key factors to consider

Here are the key points of comparison between liquid funds and fixed deposits:

Returns

FDs offer guaranteed returns at a predetermined interest rate that the bank sets. The rate typically ranges between 5%-7% per annum. Contrarily, liquid funds do not provide such assured returns. The returns earned on liquid funds are slightly higher than FDs. However, they are based on market conditions. This makes them less predictable.

Liquidity

FDs lock in your money for the chosen tenure. Banks do allow premature withdrawals to help you with emergencies, but they often come with penalties that reduce the effective interest rate. As opposed to FDs, as the name suggests, liquid funds are highly liquid. You can withdraw your money within 24 hours on business days. This makes them apt for short-term requirements.

Risk

FDs are extremely low-risk investments because they are not market-linked. Also, the Deposit Insurance and Credit Guarantee Corporation (DICGC) insures up to Rs.5 lakhs of the FD amount. Liquid funds are also low-risk investments, but they carry a slight exposure to market risks since they invest in debt securities.

Taxation

Interest earned from FDs is added to your income and taxed according to your tax slab. There is also Tax Deducted at Source (TDS) if your interest income exceeds Rs.40,000 in a year. On the other hand, liquid funds are taxed under capital gains. Short-term gains (for holding periods less than three years) are taxed as your income tax slab. Conversely, long-term gains (exceeding a three-year holding period) are taxed at 20% after indexation benefits.

Investment tenure

FDs are suitable for medium to long-term goals, and you get to choose from the flexible tenure. You can save for your specific goal and earn guaranteed returns, like education, wedding, retirement, etc. On the other hand, liquid funds are best for short-term goals or emergency funds due to their easy access and flexibility. If you have idle cash, you might need it soon, liquid funds are an excellent way to keep it accessible without compromising potential returns.

Liquid Funds vs Fixed Deposit: Which one should you choose?

When weighing between FD vs liquid funds, think about your financial priorities.

Choose an FD if:

· You want guaranteed returns and low-risk.

· You are saving for medium to long-term goals.

· You are in a lower tax bracket and the taxation on interest income does not impact you immensely.

Choose liquid fund if:

· You need quick access to your funds without penalties.

· You want a more tax-efficient option with better potential returns.

· You are looking to park your surplus capital temporarily while earning modest returns on it.

Conclusion

Both FDs and liquid funds offer valuable benefits, but they cater to different financial needs. FDs are ideal if you're looking for guaranteed returns and a safe, long-term option. On the other hand, you get flexibility, quicker access to funds, and potential tax benefits with liquid funds. Understanding how each option works and matching it to your financial goals can help you make an informed choice and create a balanced investment strategy. Whether you choose FD, liquid fund, or a mix of both, each plays a critical role in growing your savings wisely.