Liquid Funds vs Fixed Deposits

Both liquid funds and Fixed Deposits (FDs) are popular investment options for risk-averse investors. However, they differ in many respects, including their features, benefits, limitations, and market risks. Understanding various aspects of FD vs liquid funds is crucial to making an informed decision about your investment.

These investment instruments come with distinct characteristics that cater to different investment goals and risk appetites. Check out the differences between FD and liquid funds below:

While both investment options offer some liquidity with opportunities for wealth accumulation, it’s important to analyse their differences further. 

• Returns

Both investment instruments offer relatively stable returns. In some cases, liquid funds may outperform short-term FDs. However, longer-term FDs may provide slightly higher returns than liquid funds, especially during rising interest rates.

• Liquidity

You can easily withdraw from liquid funds, which makes them a suitable choice for short-term financial needs or emergency funds. Most FDs allow premature withdrawal, subject to a minimal penalty charge. 

• Risk Profile

Due to their shorter investment horizon and diversified portfolio, liquid funds are generally considered safer. They invest in short-term debt securities that are less susceptible to interest rate fluctuations. On the other hand, FDs issued by banks are insured up to ₹5 Lakhs by the Deposit Insurance and Credit Guarantee Corporation. 

• Investment Horizon

Liquid funds may be best suited for short-term goals. Their high liquidity and relatively stable returns make them an attractive investment option. FDs might be more suitable for longer-term goals like retirement planning or buying a house.

• Tax Efficiency

Liquid funds offer a significant tax advantage over FDs, especially if you fall within higher tax brackets. If you seek deductions on the principal investment, tax-saver FDs may be preferred.

These belong to the class of debt funds that invest in short-term market instruments. These instruments provide assured interest and include the following:

• Treasury bills

• Commercial papers

• High-rated corporate bonds 

• Government bonds

 

The maturity period for these instruments is up to 91 days. The main objective of the funds is capital preservation.

When you invest in these instruments, fund managers pool your money with other investors’ funds to create a corpus. Here is how liquid funds work:

• They primarily invest in short-term, high-quality, and highly liquid securities

• These funds have to invest 20% of the corpus in liquid products to ensure liquidity for redemption demands

• They mainly earn interest payments from debt holdings, along with minimal income from capital gains

• They are usually less affected by changes in interest rates due to their short-term investment horizon

It is a type of deposit that helps you earn stable returns over a predetermined investment horizon. Banks and other financial institutions provide this investment option. They generally come with higher interest rates than savings accounts.

They are a type of term deposit where you invest a lump sum amount for a fixed period. Check out fixed deposits work:

• The interest rates remain fixed throughout the tenure, which usually ranges from a few days to a few years

• Interest earned on the FD can be paid out periodically (monthly, quarterly, or annually) or at maturity, depending on the chosen option

• At the end of the tenure, you receive the principal amount along with the accumulated interest if you choose a cumulative FD 

• Interest earned on FDs is subject to tax as per your income tax slab