There is a significant overlap between the features of liquid funds and online savings accounts. So much so that it has led several customers to consider treating their liquid funds as savings accounts. Mutual fund investments are not the same as savings accounts. However, if you are considering treating your liquid fund investment as a savings account, you must keep certain points in mind.
Should you choose liquid mutual funds over savings accounts?
Here are some points that can help you decide if liquid funds are better than savings accounts:
- From a purely liquidity-centric point of view, liquid funds have the edge: Liquid funds are known for offering high liquidity to customers. It is one of the main reasons why they are viewed as alternatives to savings accounts. You can conveniently and quickly access your liquid fund investments online.
- Savings account might not always keep pace with inflation: Regular savings accounts offer lower interest rates to customers, and often cannot compete with the moderate-to-high returns offered by liquid funds. Savings accounts might not be able to keep pace with inflation at all times. A high-yield savings account might help you do so, however, it has constraints like minimum balance and limitations on withdrawals.
- Liquid funds pose a certain level of risk to the investor: Savings accounts pose a very low risk to the customer as they are generally insured by government-backed deposit insurance schemes. Liquid mutual funds, on the other hand, are market-linked. This means that – albeit lower – they do pose a certain level of risk to the investor. You can expect a fluctuation in the fund’s NAV (net asset value), for instance, resulting in minor capital losses. You must consider this point while replacing your savings account with a liquid fund.
- You must consider how liquid fund and savings account gains are taxed: You should also consider the taxation of savings accounts and liquid funds. In the case of savings accounts, the interest earned is taxable as per an individual’s income tax slab. This interest is added to the individual’s total income and taxed at the applicable income tax rate. Capital gains earned from liquid funds are taxed based on the duration for which the investor holds their liquid fund units. If your liquid fund units were purchased after 1st April 2023, the gains are classified as “short-term capital gains” regardless of the holding period and taxed according to the investor’s slab rate.
- Savings accounts do not help you diversify your capital: A major advantage of liquid funds is that they help you diversify your mutual fund portfolio. Savings account only help you park your savings in a bank account.
Should you replace your savings account with a liquid mutual fund?
There are specific advantages to investing in savings accounts and liquid funds, and you must decide on the one that offers you most benefits. You can also go for both and double the benefits!
In conclusion, you must assess your risk appetite and returns-related expectations to choose between a savings account and a liquid mutual fund.