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Liquid Funds vs Fixed Deposits vs Saving Accounts: where to keep your surplus cash for short term


Introduction:

Have you ever faced a situation where you have your goal in the very short term (anytime in the next 3-6 months) and you are accumulating funds in a savings account? For e.g down payment for your house purchase, plot purchase or building an emergency fund. Are you afraid of investing in any equity oriented funds due to market volatility in the short term? Do you want very high safety, very high liquidity and higher returns than a savings account?

Enter the world of liquid funds.Whether you're planning for a short-term goal, building an emergency fund, or simply seeking a smarter way to make your money work for you, liquid funds have got your back. They're the perfect blend of flexibility, security, and growth. Liquid mutual funds are a great choice for individuals looking to park surplus funds for the short term. They offer attractive features, including high liquidity, high safety, and potentially higher returns compared to traditional savings accounts. In this blog, we will delve into the salient features of liquid funds, reasons to invest in them, ideal investment periods, typical returns, and a comprehensive comparison with savings accounts and fixed deposits.


Salient Features of Liquid Funds:

Liquid funds possess several key features that make them an attractive investment option for individuals seeking short-term investment solutions. The following are the salient features of liquid funds:

  1. High Liquidity: Liquid funds offer high liquidity, allowing investors to redeem their investment at any time, usually within one business day.

  2. High Safety: Liquid funds invest in short-term government instruments such as treasury bills, commercial papers, and certificates of deposit issued by government entities and highly(AAA) rated corporations. This ensures relatively low risk and preserves the capital invested.

  3. Capital Preservation: By investing in low-risk instruments, liquid funds aim to preserve the capital invested while providing reasonable returns.

  4. Diversification: Liquid funds diversify their investments across various issuers and instruments, reducing the impact of defaults and providing stability to the investment portfolio.

  5. Low Expense Ratio: Liquid funds generally have extremely lower expense ratios compared to other equity mutual funds, ensuring cost-efficient investing.

  6. Systematic Investment Plans (SIPs): Investors can choose to invest in liquid funds through SIPs to build corpus for short term goals such as building an emergency fund or building corpus for yearly vacation etc.

When to Invest in Liquid Funds:

Liquid funds are ideal for various investment scenarios, including:

  1. Park Surplus Funds: If you have a lump sum amount that you need in the very short term but don’t know when exactly. For example,

    1. you are looking to purchase a house/flat/plot. You want to have the downpayment amount ready in case you get a good deal in the next few months. Liquid funds offer a viable option to earn returns on idle funds.

    2. Now looking at the job market and reading about a lot of layoffs in the market, it is very important to keep an emergency fund of at least 6 months of expenses. Since you don’t know when you need it, it is always recommended to keep it in a highly liquid instrument. Liquid funds provide easy access to funds during emergencies, allowing investors to maintain a financial safety net.

  2. Short-Term Goals: If you have short-term financial goals (e.g., daughter marriage in next few months,saving for next vacation etc), liquid funds offer a balance of safety, liquidity, and potential high returns compared to savings accounts.


Typical Returns of Liquid Funds:

Liquid funds generally provide competitive returns compared to savings accounts. However, it's important to note that returns can vary depending on market conditions and the fund's portfolio. On average, liquid funds have historically delivered annualised returns ranging from 4% to 6.5%.

Liquid Fund returns
Liquid Fund returns

Let us look at 1 year return of one of the liquid fund to understand how low volatile they are compared to other debt funds.


1 year return of Baroda BNP Paribas Liquid Fund
1 year return of Baroda BNP Paribas Liquid Fund

Now let us compare and contrast liquid funds with other competing instruments like saving accounts and fixed deposits.


Liquid Funds vs Saving Account vs Fixed Deposit

Liquid Funds vs Fixed Deposits Vs Saving Accounts
Liquid Funds vs Fixed Deposits Vs Saving Accounts

Conclusion:

Liquid funds offer a compelling investment option for individuals seeking short-term investment solutions. With high liquidity, safety, potentially higher returns, and other attractive features, they provide a viable alternative to traditional savings accounts and fixed deposits. However, it's essential to consider individual financial goals, risk appetite, and investment horizon before making any investment decisions.


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