Mutual funds are increasingly becoming the preferred option for retail investors, as reflected by the consistent monthly SIP inflows. As per the latest data released by the Association of Mutual Funds in India (AMFI), mutual funds received Rs. 12,976 crores through Systematic Investment Plans (SIPs) in September 2022 alone and Rs. 74,234 crores total in FY 2022-23 so far. (Source: AMFI)
Most traditional and conservative investors may trust bank fixed deposits to save their hard-earned money. These provide fixed and guaranteed returns without any of the volatility seen in mutual funds and other market-linked products. However, in the vast universe of mutual funds, several categories exhibit less volatility.
Liquid mutual funds belong to one such category. Liquid funds are mutual fund schemes that invest in debt and money market instruments with a maturity of up to 91 days. There is less credit risk since predominant investments are in sovereign and money market securities. Further, since the maximum maturity in liquid fund schemes can be 91 days only, the changes in market interest rates may not significantly impact the portfolio valuations. Hence interest rate risk may be lower too.
Given these advantages, liquid funds are used mainly by retail and institutional investors to manage their surplus funds while maintaining liquidity. This is also reflected in the AUM data released by AMFI, which shows that liquid funds have an aggregate AUM of about Rs. 6.5 lakh crores as of September 2022. (Source: AMFI)
So are liquid funds as safe as fixed deposits (FDs)?
While one analyses different investment options, one may wonder if liquid funds are as safe as FDs or if liquid funds are better than FDs. Fixed deposits (FDs) and liquid funds differ in various investment parameters as investment options.
Here is a fundamental analysis of fixed deposits and liquid funds:
Diversification
Fixed deposits are plain fixed-income instruments that one may hold with a bank. In contrast, liquid funds create a diversified investment portfolio of debt and money market securities, including Commercial Paper (CP), Treasury Bills (T-Bills), Certificates of Deposit (CD), etc.
Debt funds mitigate the concentration risk for the investor. In the case of FDs, the entire amount deposited with the bank may be lost if the bank has to undergo liquidation/ cancellation of the bank’s license/other such cases (subject to Rs. 5 lakh deposit insurance cover for both principal and interest amount held in the bank).
However, in the case of liquid funds, such losses may be limited since the defaulted security would only be a portion of the overall investment portfolio.
Convenience of investing
While traditional investors may find many conveniences in investing in FDs, liquid funds are also relatively easy to invest in. One can invest in liquid funds through the website/ mobile app of the mutual fund or deposit application forms at any of the Official Points of Acceptance.
Further, investors can hold their investments in liquid mutual funds in an investor folio or Demat account. Thus, it is convenient for records/reference as against FDs, which may be generally stored in physical records.
Fighting inflation
Investors may prefer fixed deposits for the guaranteed returns that they provide. However, fixed deposit interest rates may not be able to match the rate of inflation. In contrast, liquid funds provide market-linked returns to investors, wherein the investments are made in debt securities regularly at prevailing market interest rates. Investing in mutual funds like liquid funds may help absorb the impact of high inflation.
Liquidity of the investment
Fixed deposits are generally liquid but may be subject to premature withdrawal penalties and lower interest rates for the deposit tenor. As such, the overall returns for the investors may be lower than the initially contracted rate if the investor chooses to liquidate the deposits before maturity.
In contrast, the investors in liquid funds may liquidate their investments at the prevailing Net Asset Value (NAV), subject to exit load.
Periodical payouts to the investor
An investor may choose the periodical interest payout option given by the banks while creating a deposit. Such periodicity may be monthly or quarterly. In contrast, the investor can choose to invest in the 'income distribution cum capital withdrawal' option (erstwhile called dividend option) for periodic payouts from the investment.
Further, the investors may also manage the periodic cash flows through a Systematic Withdrawal Plan (SWP), which automates the regular redemption of mutual fund investments.
Tax efficiency
Interest from FDs and Short-Term Capital Gains (STCG) from liquid funds are taxable at the regular tax rates applicable to the taxpayer. However, if one has held the liquid fund units for 36 months or more, such gains are classified as Long-Term Capital Gains (LTCG) and taxed at 20% after indexation benefit.
Indexation benefit takes inflation into account for the investment period and helps taxing returns more fairly.
Given the inherent benefits and tax efficiency, investors may consider liquid funds for their investments.
Note: The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2022 presented in the Parliament in February 2022. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the investment date. Please contact your tax advisor for professional tax advice.
Disclaimer:
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
To know about the KYC documentary requirements and procedure for change of address, phone number, bank details, etc. please visit https://www.utimf.com/servicerequest/kyc. Please deal with only registered Mutual funds, details of which can be verified on the SEBI website under "Intermediaries/market Infrastructure Institutions". All complaints regarding UTI Mutual Fund can be directed towards service@uti.co.in and/or visit www.scores.gov.in (SEBI SCORES portal). This material is part of Investor Education and awareness initiative of UTI Mutual Fund.
