Have some surplus money to invest, but in a dilemma between the stability offered by fixed deposits and handsome returns of liquid funds? Well, no worries as you are not the only one with this dilemma. This kind of dicey situation often happens while choosing between two savings options with great features like liquid funds vs FD. Before delving deeper into the comparison parameters, it is imperative that you know what actually does a liquid fund and fixed deposit in India means.
What are Liquid funds?
To understand the meaning of liquid funds, first, you should understand what mutual funds are. Mutual funds are the type of investment tools that pool money from different investors with the same kind of investment objective and invest it across either different asset classes or companies of varying market capitalization. The investor, in turn, earns money either by way of dividend income or capital gains.
Liquid funds are one of the types of mutual funds and are a short term investment tool. Under these funds, the investors’ money is invested into debt-based securities and fixed income earning instruments like treasury bills, call money and commercial papers with a period of maturity up to 91 days. What’s more enticing is that whenever an investor wants to redeem his/her money, the amount is credited to their bank accounts within 24 hours. Now the question arises: is liquid fund better than FD? Well, let’s check out what is an FD and how it works; then only we can compare both of them based on several parameters.
What is an FD?
A fixed deposit is a form of bank deposit that comes with a certain lock-in period/tenure. Almost all the banks and other NBFCs (Non-banking financial companies) in India provide this scheme with attractive interest rates. Under this scheme, an investor needs to at least deposit the minimum deposit amount for a certain period of time and upon maturity, one can enjoy the interest along with the principal amount.
Liquid Funds vs Fixed Deposits – A detailed comparison
Both the investment options can be compared based on several parameters which will allow investors to make the right choice on clear grounds. Here are a few factors that you can bring into use before making your decision:
- Risk factor
- Funds Availability
- Returns
- Liquidity
- Taxation
Now, let’s have a look at how each of these parameters varies for liquid funds and fixed deposit:
Risk factor
One of the vital factors considered for any kind of investment is the type of risk associated with it. FDs are considered to be no-risk investments as the interest is provided as promised. On the other hand, investing in liquid funds carries a certain amount of risk associated as already mentioned it is one of the types of mutual funds and these are linked with market volatility.
Funds Availability
It is mandatory to invest a lump sum amount in an FD at one go, whereas liquid mutual funds allow an investor to set up a systematic investment plan (SIP) and invest a certain amount on a monthly basis. This helps to instil financial discipline into an investor and diversify the risk of the portfolio.
Returns
FDs carry a pre-fixed rate of return, which does not change during the entire period of investment. Furthermore, the longer the tenure, the higher the rate of interest provided to both general and senior citizens. For a lower tenure, the respective interest rate is also low.
In the case of a mutual fund, returns are not based on a fixed and pre-determined rate. The return on investment (ROI) is influenced by the ups and downs in the market. Coming to the risk part, equity mutual funds are known to carry a higher level of risk while debt funds carry a comparatively lower risk.
Liquidity
Fixed deposits have a fixed maturity period or tenure before which one cannot redeem the funds unless there is an emergency. Thus, it can be said that it carries very low liquidity until the end of the tenure. In other words, if you break an FD before it matures, a penalty is usually charged and you may have to forego a part of your earnings. However, post the tenure, the entire principal and interest may be credited to your savings or current account within an hour. On the contrary, liquid mutual funds returns may be redeemed at any point in time, however, with an exit load.
Tax on liquid funds vs fixed deposits
One of the major factors which should be considered while comparing FD vs liquid fund is the taxation treatment. In the case of FDs, the tax is levied as per the current tax slab of the investor. Whereas when it comes to liquid funds, the dividend received is tax-free. The gain or loss impact on a mutual fund depends on the type of fund chosen. For example, for equity funds, the short-term capital gain (STCG) is taxable at 15% and the long-term gain (LTCG) is tax-free. For debt funds, the short-term capital gains are taxed as per the income slab of the investor and the long-term capital gain is taxed at 20% with indexation and 10% without indexation.
Fixed Deposits vs Mutual funds – Key differences
The differences stated above are briefed as per the parameter in a tabular format given below. Hope this helps in remembering the key difference between both of them:
| Parameter | Fixed deposits | Mutual funds |
| Risk Factor | Low risk | Medium to high risk |
| Returns | Fixed preset return | No guaranteed return; depends on market conditions |
| Liquidity | Medium to high liquidity | High liquidity |
| Taxation | According to the tax slab | Favorable tax status for long-term investment |
| Withdrawal | Allowed with a penalty | Allowed with an exit load |
On a closing note
Taking into account the various aspects of both the investment tools, it may be concluded both of them have their pros and cons for a separate investor base. You can select from the best Liquid funds available in the market as they will fare better than FDs if an investor has a higher risk appetite and prefers to invest for a long tenure, as investing in mutual funds will give a higher return. For risk-averse individuals, FDs seem to be a more ideal way of investment owing to the assurance of returns.