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Savings vs Liquid Fund: Which one is the best for you?

Planning to open an emergency fund? Choose wisely between savings account and liquid fund.

In life, we all need money that we can withdraw whenever we want. It is a healthy practice to keep certain amount of money as a contingency fund is case of emergencies such as job loss, accidents etc. Experts recommend that 3 to 6 months of expenses should be in our emergency fund.  As we can’t afford to keep it in cash, a financial product that keeps our money safe from theft and at the same time keeps money readily available is required. Savings and liquid funds are two such financial products that can help you keep your money safe and at the same provide you with decent rate of interest. Although, both can be used to park excess funds, the savings bank account and liquid funds are very different from each other.

Let us understand the few differences between savings account and liquid fund:

Categories:

Savings account is a product of the banks and every bank account has a few types of savings account. There are savings account meant specially for women, children, senior citizens etc. Savings accounts are of various categories and hence it caters to the different types of individual. Women savings account has benefits meant for the women customers and senior savings schemes provide around 50 bps more interest rate than a normal saving account.

On the other hand, liquid fund is a category of debt mutual fund. Unlike savings accounts, it does not have different categories of liquid fund to cater to the different categories of customers.

Tip: If you want variety and personalisation, go for savings accounts.

Risk:

Savings account and liquid funds have different risks as well. Savings account is a risk free saving avenue. If you have Rs. 1 lakh in your savings account, there are no chances of the money reducing in value. Savings accounts have fixed interest rates which is updated on a regular basis.  The interest rate offered by the savings account differs from bank to bank. The largest bank in the country SBI offers an interest rate of 3.25% on their savings account. Other banks such as Kotak Mahindra Bank give an interest rate of up to 6%.

However, liquid funds carry higher risk than savings account. The mutual fund houses can’t guarantee any rate of return. Although liquid fund has the lowest risk level among all the mutual fund categories, the securities held by the liquid fund are prone to downgrade and defaults. Recently, liquid funds have been in the eye of the storm after multiple defaults by companies such as IL&FS and Essel. The defaults and redemption pressure by investors adversely impacts the unit price of the mutual fund. Hence, in liquid funds, your invested money can also reduce.

Tip: Savings account is the better option if you don’t want risk.

Need for immediate cash:

Liquid funds and savings account are two of the most liquid saving option. However, savings accounts are more accessible than liquid funds. In case of a savings account, one can easily withdraw cash from the ATMs or through withdrawal slips. The daily withdrawal limit from a bank ATM depends on the type of savings account and bank.

In case of liquid funds, not all liquid funds have the facility of instant redemption. In case of instant redemption, investors can redeem up to Rs.50,000 in a day. If the redeemed amount is higher than Rs.50,000, the remaining amount is credited within 3 working days. Hence, redeeming from liquid funds during an emergency on holidays can be a little problematic.

 Tax saving:

The tax calculation of savings account and liquid fund is different. In savings accounts, interest of up to Rs.10,000 from savings bank account is tax free.  For example, if your bank account gives you an interest rate of 6%, then you don’t have to pay any tax on deposit of around Rs.1.60 lakh in your savings account.

On the other hand, tax on liquid funds depends on your holding period. The taxation of liquid funds is as per taxation of debt mutual funds. Short term capital tax and long term capital gains tax are applicable for liquid funds. Short term capital gains is applicable if the redemption is made within three years of investment and it taxed according to your income slab. In case of long term capital gains, the gains are taxed at 20% along with indexation. Indexation helps to show whether the rate of return of the instrument has been higher than the inflation rate and taxes are only applicable on the amount that has grown higher than inflation.

Tip: The indexation benefit makes liquid funds better than savings account when it comes to taxation.

Liquid funds and savings account can help you to park your excess cash for emergency or other situations. However, they are not similar and hence, it is important to understand the nuances before opening a savings account or a liquid fund.

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A zero balance account vs a regular savings account

ABCs of Mutual Funds

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