Ever since Reserve Bank of India (RBI) raised the repo rates for the third consecutive time on August 5, a number of commercial banks and non-banking financial corporations (NBFCs) have raised interest rates on their term deposits, thus drawing retail investors to invest in these safe investment instruments over a gamut of other options.
Another alternative for conservative investors is liquid funds. Here we give a lowdown on the factors one should weigh before choosing one investment option over the other. But before we procced further, we explain what exactly are liquid funds.
Liquid funds are debt funds which invest in a slew of fixed income instruments such as commercial paper, government securities, treasury bills carrying a maturity of up to 91 days. These funds usually have the lowest interest rate risk among debt funds.
Tax expert and Mumbai-based chartered accountant Chirag Chauhan says that fixed deposits (FDs) tend to offer a higher yield over liquid funds and hence, they should be prioritised over the latter.
“Fixed deposits are better than liquid funds as they are more secure and offer a higher interest income. On FDs, one has to pay tax on interest income at the rate applicable in the slab. Whereas in case of liquid funds, depositor has to pay tax on long term capital gain when they are redeemed after holding for three years, and on short term capital gain when redeemed prior to three years,” says Mr Chauhan.
|Fixed deposits||I. Interest income taxable|
|II. Exempt up to ₹10,000|
|III. Above this, it is taxable as per tax slab rate|
|Liquid Funds||I. Capital gains tax levied at the time of redemption|
|II. Short term capital gains tax when redeemed within three years of purchase|
|III. Long term capital gains when redeemed after three years (20 percent).|
While speaking about the return after factoring in the applicable tax, Mr Chauhan said that the pre-tax returns should also be compared and between the two investment instruments, FDs score over liquid funds and hence, it is futile to pay attention to give undue emphasis on tax outgo. “Post tax returns are likely to be higher for FDs when they are compared with liquid funds,” he added.
Time duration matters too
At the same time, some believe that liquid funds are a better investment for a short duration such as a few weeks, while for the long duration, investors can prioritise a fixed deposit, although one can also opt for a high yielding debt mutual fund instead.
“Liquid Fund dividends and FDs have similar tax treatment. Whether you should choose one over the other depends on the investment objective. For short term requirements (say a few weeks), liquid funds are a good option, they have daily liquidity and no exit loads beyond one week,” says Abhishek Dev, Co-Founder and CEO, Epsilon Money Mart.
“For longer periods, you can compare with FDs though be mindful of the pre mature withdrawal penalties should you need to withdraw earlier than FD maturity. Mutual funds have different debt products for different time horizons (i.e., low duration funds, short term funds etc) and you may wish you consider them as well before making a decision for a particular investment horizon,” he adds.