Liquid Funds are a good alternative to FD and saving account in order to park money for short term. 🔼Liquid funds gives an option that gives you liquidity (as the name suggests) but also good returns. Most liquid funds do not have an exit load, so you can have your money with 1 working day from the point you decide to cash the funds. Liquid funds are basically debt funds, who in turn invest in govt bonds, commercial corporate bonds etc and they provide a annual return somewhere between 7-9%. Main benefit of liquid fund is that you can invest here for even one day or more and get the returns.
💹Another, reason people invest in liquid funds is because brokers earn only on “fund circulation”, so they ask you to invest in liquid funds and then transfer some to one mutual fund and then again to some other equity mutual fund or liquid fund etc, gaining brokerage/commissions each time. 💹Last reason for investment in liquid funds is the latest trick being deployed by zero brokerage funds like zerodha to invest the remaining cash left in your brokerage account to liquid funds (and hence get referral commissions etc probably) instead of SEBI mandatory automatic transfer of funds to your bank account directly, at the end of each quarter.
⚓For a Standard Retail Investor, Liquid Funds are actually not at all suitable. They may consider ITC as the best Liquid Fund, putting all the funds they don't need and keep withdrawing directly from their anytime they need. Here, safety is as good as any liquid funds, gains are at least around 15% per annum and you can always withdraw within max T+2 days.
This almost doubling of the returns on your spare cash may create a wonder for you in long run.
Taxation on Liquid Funds:-
Capital gains on liquid funds are taxable.
If you sell your funds before three years (36 months), you will have to pay short-term capital gains tax. Short-term capital gains are added to your income and taxed as per the income tax slab applicable to you. 🔼If funds are held for more than three years, your gains will qualify for long-term capital gains tax of 20 per cent with indexation benefit on your original investment.
Here also, Stocks directly are much more efficient as in them as they become completely tax free after just one year period (in Stocks, Long Term means more than One Year Only). Even for Short term, taxation rate is a lesser 15% only.
Taxation on Liquid Funds and Other Mutual Funds for NRIs:-
🔼The short-term and long-term capital gains taxes on mutual funds are the same for Non Resident Indians (NRIs) and Indian investors.
The only difference is that in the case of NRI investors the short-term and long-term capital gain taxes will be deducted at the time of redemption. 🔼For Indian Investors, full amount is redeemed and the investor then needs to do the calculations and then pay the taxes while filling the ITR.
The Double Taxation Avoidance Agreement (DTAA) should help NRI investors to avoid double taxation of the same income in India and their resident country.
Query from Investors basis future needs:
“I want to buy a car in next 1 year, where can I invest my money for 1 year?”
“I want to save Rs 2 lakh for emergency like medical expenses, where can I keep my money?”
“I just want the best option to invest my money where I have freedom to take out whenever I want”
🔼Well, this is a classic case where every person want to save some money for buying stuff in few months or just want to save some money for emergency purpose like medical expenses, etc.
Most of the people put their money in saving account or make an FD.
But is it a good option to invest money? Well, No!
I understand that stock market and mutual fund are not suitable for short term investment as it involves high risk.
But is their any other option? Well, Yes!
Example with calculation:
In August 2019, Sameer and Vishal wanted to invest some money. Both were looking for investment option from where they can take out money, if required.
Sameer decided to go ahead with FD. Vishal decided to go ahead with Liquid Fund.
Fast Forward in July 2024, Virat earned 12.8% more than Sameer. In absolute terms, Vishal had ₹ 81,628 more than Rohit.
(If Sameer would have been in 20% tax slab, Vishal would have earned ₹ 62,574 more than Sameer.)
Let’s see the calculations:
Sameer's Scorecard
Investment Date: 1st August 2019
Invested amount: ₹ 5,00,000
Withdrawal date: 31st July 2024
Return Rate: 6.75% (one of the highest FD rates)
Year 1 return: ₹ 5,33,750 (Invested Amount*(1+Return rate))
Interest Income: ₹ 33,750 (Year 1 return - Invested Amount)
TDS Deduction: ₹ 3,375 (10% of Interest Income)
Assuming Sameer is in 30% tax slab: He has to pay extra 20% on interest income: ₹ 6,750 (20% of Interest Income)
Sameer has to pay TDS as well as tax every year on interest income.
Hence, at the end of 5th year, Sameer received ₹ 6,33,375 after tax.
Vishal’s Scorecard
Investment Date: 1st August 2019
Invested amount: ₹ 5,00,000
Withdrawal date: 31st July 2024
Return Rate: 8%
Compounded Amount: ₹ 7,34,664 (Invested Amount* (1+Return rate)^5)
Profit: ₹ 234,664. (Final Amount - Invested Amount)
Tax Calculation
Inflation index in 2019 : 220
Inflation index in 2024: 280
Index cost: ₹ 6,36,363 ( Invested Amount * (Inflation index in 2018/ Inflation Index in 2013)
Capital gain: ₹ 98,301 (Compounded Amount - Index cost)
Tax: ₹ 19,660 (20% of Capital gain)
Final Profit After Tax: ₹ 2,15,004
Final Amount After Tax: ₹ 7,15,004
Did you notice the difference?
- Liquid Fund is taxed at indexation after 5 years. This is not the normal flat tax like FD.
- Every year, bank deduct TDS over interest income ₹ 10,000 and hence that amount is not used in compounding whereas as Liquid fund had tax deduction only in last year.
- Interest on FD is fully taxable. Every year, over and above TDS, you need to pay the interest on income from your FD based on your income tax slab.
🔼Conclusion: Liquid fund is better than FD and arguably the best option of investment for liquidity.
Kay Take Away 1: When it come to investment, there is no “One size fit all” strategy. The above explanation is for illustration and help to understand the difference between FD and Liquid fund. Every individual investment differs based on risk appetite and individual goals.🔼
Key Take Away 2: Interest income on FD is fully taxable. If interest income is more than ₹ 10,000 then 10% is deducted as TDS by bank. Over an above tax would be paid based on income slab. E.g. If you fall under 30% income slab and interest income is ₹ 50,000 then bank will deduct TDS of ₹ 5,000 and you have to pay the difference of ₹ 10,000 as 30% of ₹ 50,000 is ₹ 15,000. This is repeated every year.🔼
Key Take Away 1 :
Liquid Fund Risk: Liquid funds put money in assets with short term maturity of up to 91 days. They invest in instruments such as treasury bills, certificate of deposit, etc. They hold very little risk.🔼