Liquid funds vs savings bank account: Pros and cons of each

Posted On: 27 March 2024

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

What is a savings bank account?
What are liquid funds?
Difference between liquid funds and savings account
Pros of liquid funds over regular savings accounts
Cons of liquid funds compared to regular savings accounts
Factors to consider when choosing between liquid funds and regular savings accounts
Liquid fund vs savings account: Which one to choose?
When should you put extra cash in liquid funds?
How do liquid funds compare to fixed deposits and savings accounts?

What is a savings bank account?

A savings bank account is a financial vehicle most of us are familiar with. It is a basic bank account where individuals can park their surplus funds, offering easy accessibility and minimum risks. Banks also offer interest to the account holders for choosing to keep their money with them.

What are liquid funds?

Unlike savings accounts, liquid funds come under the category of mutual funds. They are market-linked instruments that invest in short-term, highly liquid instruments such as treasury bills, certificates of deposit, commercial papers, and even short-term bonds. They invest in instruments up to 91 days. They avoid investing in stocks or any other high-risk instrument, making them a viable choice for investors with low risk appetite. Liquid funds are managed by Assets Management Companies (AMCs) or fund houses. Liquid funds have the potential to offer relatively better returns than savings account along with the flexibility to access funds swiftly.
Having said that, the returns on liquid mutual funds are always at a risk of changing and there is no assurance of returns on liquid funds. Additionally, there is credit risk that can impact the potential returns earned by investors.

Difference between liquid funds and savings account

Returns: This is one of the major differences between liquid funds and savings accounts. The interest that an account holder can earn from his savings account is usually lesser than the returns from liquid funds. However, it must be noted that since the returns in case of liquid funds are market-linked, profit is not guaranteed.
Liquidity: Both savings accounts and liquid funds offer a certain level of liquidity. With a savings account, you have the freedom to withdraw money at any time through various channels such as ATM withdrawals, online transfers, or bank visits. Liquid funds, although not as instantaneous as a savings account, typically provide redemption proceeds within T+1 business days. However, liquid funds also provide an option of insta-redemption wherein up to Rs. 50,000 or 90% of your investments, whichever is lower, can be received by you within few minutes of undertaking transaction of insta-redemption.
Risk and safety: Savings accounts are considered low-risk instruments. On the other hand, while liquid mutual funds are relatively stable due to their investment in highly rated debt instruments, they do carry a certain degree of market risk. However, it’s important to note that liquid funds are regulated by the Securities and Exchange Board of India (SEBI) and have strict investment guidelines to ensure relative stability to investor’s investments.
Diversification of investment: When you keep your surplus money in a savings account, your funds are parked with a single bank. On the contrary, liquid funds build a diverse portfolio by investing in various money market instruments issued by different entities.

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.

Liquid fund vs savings account: Which one to choose?

The choice between liquid funds and savings accounts ultimately depends on your financial goals, risk appetite, and liquidity requirements. If you prioritize safety, easy accessibility, a savings account might be the suitable choice. It offers peace of mind and allows you to withdraw funds whenever needed.
However, if you are willing to take a little risk with a vision of relatively better return potential, then a liquid mutual fund can be a suitable option. It's important to evaluate your short-term and long-term financial goals and consider your emergency fund requirements before making the final decision. Consulting with a financial advisor can also provide valuable insights based on your specific circumstances.

When should you put extra cash in liquid funds?

Let’s assume you receive a large sum of money – such as a bonus or a gift. You don’t need the money right now, but you have some expenses lined up in a few months and so you don’t want to lock away the surplus. Instead of leaving the money in your bank account till you need it, you can consider investing it in a liquid instrument where it has the potential to earn relatively reasonable returns.
The time-tested fixed deposit is one such way to set this money aside for a few months and earn interest on it. Another option is to invest in liquid funds. Such funds have the potential to earn similar or better returns than a fixed deposit over the same tenure. However, unlike fixed deposits, the returns form liquid funds aren’t guaranteed and are subject to market risks. Moreover, they are highly liquid, so you can initiate a redemption whenever you need the money, and it reaches you within a day or two. Some fund houses also offer instant redemption of up to a certain amount, wherein money (up to Rs. 50,000 or 90% of the invested amount) is credited to your bank account within 30 minutes.

How do liquid funds compare to fixed deposits and savings accounts?

Liquid fund investments have an exit load period of seven days, after which redemption is without exit load. In comparison, most fixed deposits charge a penalty for premature withdrawal.
When you invest in liquid funds, you can also make partial redemptions, top up your savings, or stay invested for as long as you need to. In comparison, a fixed deposit has a fixed tenure, and you would need to start a new FD each time you want to put in more money. In comparison to a savings account, liquid fund investments have the potential to yield relatively better growth but at a higher risk than savings account. Liquid funds are also beneficial for mutual fund investors who have opted for a Systematic Transfer Plan, wherein money is routinely transferred from one scheme to another – such as from debt to equity – to help withstand market fluctuations. You can also invest in liquid funds to park funds before switching to an equity fund or another instrument with relatively better growth potential.

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.

How are liquid funds different from a regular bank savings account?

Liquid funds and savings accounts differ in several aspects. Liquid funds offer potentially better returns but with some degree of market risk, while savings accounts provide fixed, lower returns and are considered risk-free. Returns in liquid funds are not guaranteed and depend upon market conditions. These funds are very liquid, but instant redemption facilities may not be offered by all fund houses and there may be a cap to the amount that can be instantly redeemed.

Liquid funds are suitable for those seeking better return potential than savings accounts, while savings accounts are better for those prioritizing capital stability and instant access to cash through multiple channels.

Should I choose a liquid fund or a bank savings account?

The choice between a liquid fund and a savings account depends on factors like risk tolerance and financial goals. Savings accounts offer stability and instant access, while liquid funds offer better return potential but with some risk. Investors may also consider using both avenues – such as keeping money for day-to-day expenses in a savings account and parking surplus money in liquid funds for better return potential.

What is the difference between liquid funds and a savings account?

Liquid funds are a type of mutual fund that primarily invests in short-term debt securities with a maturity period of up to 91 days. Whereas a savings account is a bank account that allows individuals to deposit and withdraw money while earning interest on the balance.

Which option offers higher returns: liquid funds or a savings account?

Liquid funds generally have the potential to offer higher returns as compared to savings accounts. Investing in Bajaj Finserv Liquid Fund can help investors meet their short-term investment needs. This scheme aims to provide the investors with a steady income with the preservation of capital, lower risk, and high liquidity. However, it's important to note that unlike savings accounts, liquid funds are subject to market risks, and returns are not guaranteed.

How accessible is the money when you invest in liquid funds compared to a savings account?

Liquid funds are designed to provide easy access to invested funds. In most cases, you can redeem your investment and receive the funds in your bank account within T+1 business days. Additionally, liquid funds also provide option of insta-redemption, wherein up to Rs. 50,000 or 90% of your investment, whichever is lower, can be received by you within a few minutes of undertaking insta-redemption transaction. On the other hand, savings accounts offer immediate access to your money through various channels such as ATM withdrawals, online transfers, and debit card transactions.

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.