Have you been idling large sums in your savings bank account just to provide for any unforeseen need? If so, you could have managed 5-6 percentage points more by setting aside at least a part of your money in liquid funds and still have liquidity.
Yes, liquid funds, offered by mutual fund houses, invest in short-term money market instruments such as government securities, treasury bills and commercial paper. In a way, they park your money in instruments not too different from the way banks do and hence are reasonably secure. On the flip side, they cannot provide you fixed returns the way savings bank accounts do. They do not also offer a deposit insurance of up to Rs 1 lakh that your balance in savings and deposit accounts enjoy.
And yet, their returns, as the table below suggests, have been far superior to savings bank rate. Although saving bank rates have been deregulated by the RBI, only couple of banks offer 6% to 7%. The rest give you only 4% currently.
Features of liquid funds
• Invest in short-term government securities and certificate of deposits, making them reasonably secure
• Provide flexibility to invest or withdraw any time without any exit load or penalty.
• Some mutual fund houses even offer an ATM card to withdraw the funds
• Tax efficient schemes
• Have historically provided higher returns than savings bank interest rate
When to use
• To create an emergency fund which can be withdrawn any time
• To temporarily park any lump sum you may have received
• To save for short-term goals such as saving for an impending vacation or for short-term obligations
• To park money and systematically invest in other high yielding schemes such as equity funds
How to plan
Segregate the money in your savings account into two: one, the sum that you need for your day-to-day operational cash flows and the rest for contingencies or for a short-term goal. Let the first part remain in your savings account as you need this for your daily expenditure. Shift the rest to a liquid fund. If you have a time frame of over 3 months then you can consider ultra-short-term funds as well. This can give you slightly higher returns than liquid funds.
Being tax efficient
Did you know that you need to pay tax on the interest that your savings account balance fetches? Yes, such interest income is taxed at the tax slab in which you fall – 10%, 20% or 30%. Liquid funds too, are taxed (as capital gains) in the same rate if held for less than one year (indexation benefits are available for holdings greater than one year).
But you can plan to reduce the impact of capital gains tax in liquid funds. Here’s how: if you are in the high tax bracket of 30% opt for dividend payout or daily dividend reinvestment. This will reduce or nullify your capital gains. If you are in the lower tax bracket, you can instead take the growth option since the tax rate is anyway low.
Corporate houses have been using liquid funds to park their daily surpluses and derive some returns. As retail investors, you can take also benefit from these schemes.
Birla Sun Life Floating Rate Short Term Plan, DSP BR Liquidity and HDFC Cash Management Savings Plan are some of the liquid funds that you can consider.