Understanding the pros and cons of liquid funds over regular savings account

A savings account is one of the safest places to park money. However, liquid mutual funds are also emerging as a potential alternative or supplement owing to their potential to yield better returns than savings account with relatively stable capital and liquidity, at a higher risk than savings account. Both have unique features and benefits, making them apt for different financial goals.

• Table of contents

1. Pros of liquid funds over regular savings accounts
2. Cons of liquid funds compared to regular savings accounts
3. Factors to consider when choosing between liquid funds and regular savings accounts

Pros of liquid funds over regular savings accounts

Liquid funds are a category of fixed-income mutual funds that invest in high-quality debt and money market securities such as treasury bills, commercial papers, and certificates of deposit with a maturity of up to 91 days. Here are some of their advantages:

• Relatively higher returns potential: Liquid funds have historically tended to yield relatively higher returns than regular savings accounts. They earn primarily through interest payments on fixed-income securities.
• Instant access to funds: Liquid funds provide easy access to your money because of the liquidity of their underlying securities.
• Low risk: Compared to other mutual fund categories, liquid funds carry relatively low risk. They invest in short-term instruments with high credit quality, thereby reducing the impact of market volatility.
• No lock-in period: Unlike fixed deposits, liquid funds do not have a lock-in period. You can withdraw your investment at any time without penalty. However, investors will be charged exit load for redemption within a certain time period from the investments done.

Cons of liquid funds compared to regular savings accounts

• Market-related risks: Although relatively low, liquid funds carry some market-related risks. Their returns are not guaranteed, unlike the fixed interest from a savings account.
• Costs and charges: Liquid funds may have associated costs such as fund management fees, which can slightly reduce the net returns.
• Complexity: Understanding and managing liquid funds require more financial knowledge, while savings accounts are straightforward.
• No insurance cover: Savings accounts in India are insured up to a certain amount, offering a safety net that liquid funds do not provide.
• Not for instant transactions: Some funds may require you to wait up to a day for redemption requests to be processed, making them more liquid than most mutual funds but not as liquid as savings accounts. Also, insta-redemption facility is available. It allows you to redeem Rs. 50,000 or 90% of the invested amount, whichever is lower, within a short span.

Factors to consider when choosing between liquid funds and regular savings accounts

• Risk appetite: If you prefer stability over higher return potential, a regular savings account might be better. For those willing to take on a little risk for better return potential, liquid funds are suitable.
• Investment duration: For short-term goals, liquid funds are ideal. However, for immediate and frequent transactions, a savings account is more convenient.
• Financial goals: Align your choice with your financial goals. Liquid funds can be part of a larger investment strategy, while savings accounts are better for everyday financial needs.
• Liquidity needs: Assess how quickly you might need to convert your investment into cash. Liquid funds offer high liquidity, but a savings account provides instant access without any processing time. Also, insta-redemption facility is available. It allows you to redeem Rs. 50,000 or 90% of the invested amount, whichever is lower, within a short span.
• Financial knowledge and comfort: Managing liquid funds requires a basic understanding of financial markets. If you're not comfortable with this, the simplicity of a savings account might be more suitable.
• Purpose of funds: Consider why you're saving. For emergency funds, the immediacy of a savings account is beneficial. For surplus funds, where immediate access isn't crucial, liquid funds could be more suitable.
• Inflation impact: Savings account interest rates often don't keep pace with inflation, potentially diminishing the purchasing power of your savings over time. Liquid funds, with potentially higher returns, may better counteract inflation.
• Investment diversification: If you're looking to diversify your investment portfolio, including both liquid funds and savings accounts can be a wise strategy, balancing risk and accessibility.

Conclusion

The choice between a liquid fund and a regular savings account depends on individual financial needs, goals, and risk tolerance. Liquid funds offer a higher return potential and flexibility but come with some market risks. Savings accounts provide stability and ease of use, though with lower returns. Weighing the pros and cons of liquid funds over regular savings accounts is essential in making the right choice for your financial future. Investors may consider the Bajaj Finserv Liquid Fund, which seeks to provide a level of income consistent with the objectives of preservation of capital, lower risk and high liquidity through investments made primarily in money market and debt securities with maturity of up to 91 days only.

FAQs:

How do liquid funds differ from regular savings accounts?

Liquid funds are mutual funds that invest in short-term market instruments, offering a modest return potential but with some level of risk. Savings accounts are low-risk bank accounts with fixed interest rates.

Which is better: liquid fund or savings account?

It depends on your financial goals and risk tolerance. For higher return potential and flexibility, liquid funds are suitable. For safety and ease of use, savings accounts are preferable.

What are the advantages and disadvantages of having liquid savings?

Advantages include higher return potential and quick access to funds. Disadvantages involve market risks and potential management costs.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.