Liquid Funds V/S Fixed Deposits: Comparison Of Returns

Liquid funds are an ideal alternative to fixed deposits as they invest in low-risk debt and money market securities. The income from these securities in the form of accumulated interest and any gains on market price are then passed on to investors through a daily net asset value (NAV) of units. These units can be bought and redeemed at any point.

Despite investing in securities which are valued at market price, the price movement in liquid fund NAV is quite low, unlike with other schemes. Accumulated interest gets added to daily NAV, making it a good choice for short-term savings.

However, unlike with fixed deposits, you will rarely see a defined return being advertised because for market-linked securities like mutual funds, returns are not assured in advance. Further, it is against regulations to do so. What one should instead be guided by is the performance track record and consistency of a given liquid fund or a fund manager.

Returns shift with rates

Like fixed deposit rates, liquid fund returns shift based on the prevailing interest rate in the economy. In India, the repo rate is the benchmark which drives most other interest rates. Repo rate in India has moved lower, from 8% in 2014 to 6% now. Liquid funds invest in upto 91-day maturity bonds and money market securities, and a high proportion of this supply comes from the banking and finance sector. Interest received on these securities moves with the change in repo rates as well. This is not unlike fixed deposit rates, which also move up and down as the economy interest rate changes.

For example, from a high of 9% in 2014, the one-year SBI fixed deposit rate is now at 6.80%. Liquid fund returns too have declined from 9-9.2% annualized return in 2014 to around 7-7.5% now.

Apart from the accumulated interest, liquid funds earn from the rise in market price of securities they hold. This adds an edge to overall returns. Here, the fund management quality matters on two fronts – the ability to maximize such opportunities and to keep credit quality in check. Also, keep an eye on the volatility indicator or standard deviation of monthly returns for these funds for the previous 1-2 years. The lower, the better.

So even though there is no defined interest paid out on such securities, it is possible to assess the expected return.

Flexibility and taxation

While the returns alone may not always give liquid funds an edge, what you have to consider is the flexibility to redeem them at any time. Money is credited within one working day. The instant redemption facility cleared by the regulator enables immediate receipt of up to Rs 50,000 from funds which offer this. Effective dividend distribution tax at 29.12% is lower than the highest tax applicable on fixed deposit interest for investors who fall in the 30% tax bracket.

To sum it up, liquid funds not only offer a typically higher return than fixed deposits as a result of being invested in low-risk debt and securities, but they offer an extremely flexible alternative for investors who have the option to redeem their returns when they please.