How liquid funds returns compare with fixed deposit interest
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Liquid funds are an ideal alternative to fixed deposits given that they invest in low-risk debt and money market securities. The income from these securities in the form of interest accumulated 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.
Unlike other schemes, despite also investing in securities which have to be valued at market price, the price movement in liquid fund NAV is low. The accumulated interest gets added to daily NAV, making it a good choice for short-term savings.
However, unlike 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. It is also against regulations to do so. What one can rely on is the performance track record and consistency.
Returns shift with rates
Like the fixed deposit rates, liquid fund returns also shift based on the prevailing interest rate in the economy. In India, the repo rate is the benchmark which drives most of the other interest rates. Repo rate in India has moved lower from 8% in 2014 to 6% now. Liquid funds invest in up to 90-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 also moves with the change in repo rates. This is not unlike fixed deposit rates, which too 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 6.75%.
Liquid fund returns too have declined from 9-9.2% annualised return in 2014 to around 6.5-7% now.
Apart from the accumulated interest, liquid funds also earn from rise in market price of securities they hold. This adds an edge to overall returns. Here, the fund management quality matters on two fronts; ability to maximise such opportunities and keeping 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 it is, the better.
Hence, even though there is no defined interest paid out on such securities, you can assess the expected return.
Flexibility and taxation
Looking at just the returns may not give liquid funds an edge. What you have to consider is the flexibility to redeem it anytime. Money is credited within one working day. The instant redemption facility cleared by the regulator will enable immediate receipt of up to Rs50,000 from funds which offer this. Effective dividend distribution tax at 28.84% is lower than the highest tax applicable on fixed deposit interest for investors who fall in the 30% tax bracket.