For most investors & corporates, saving & current bank account becomes the preferred destination to park their short term surplus funds. Further, even when they need to build a contingency fund, they cannot think of better havens.
The reason for such a decision might be lack of awareness or a time crunch. However, leaving your short-term funds in a saving or current bank account is the least efficient way from an investment standpoint.
There is a better a better way to deal with short term surplus cash. Invest your short-term funds in “Liquid Funds”. Liquid funds have evolved as an ideal haven for short-term investors. They are a convenient means to earn better returns as compared to a savings bank account and use your current account like a savings account with superior returns.
Liquid Fund is a type of debt mutual fund, open-ended scheme which have a short-term investment horizon. These invest in money market instruments like the certificate of deposit, treasury bills and commercial paper of up to 91 days. The investment objective is to preserve capital and provide income via creating ample liquidity. You can choose to invest for a few days or months depending on your financial needs. The fund returns are according to the prevailing market rates. The best part is that there is no exit load applicable for liquid funds. These are available in variants like Daily/Weekly/Monthly Dividend and Growth option. You can earn steady returns over short time intervals. Moreover, you can redeem a part or the entire amount of investment within 24 hours.
From a returns perspective, saving accounts mostly offer about 3.5% return. Current account holders don’t earn any returns. For an individual falling in the highest tax bracket, the post-tax returns on savings account would be around 2.5-3%. For Corporates, there are no returns on current accounts. Therefore, to make better use of short-term funds, liquid funds are a better alternative. On an average, returns generated by liquid funds are in the range of 6.5% to 8%. The post-tax return would be around 5% to 6%, which is fairly higher than the savings account. Liquid funds on an average have been giving about 7-7.5% returns over the last 12 months.
You may regard savings account as something which generates a risk-free return. It means that you are assured of the interest being credited to your account. Moreover, the banks do not change the interest rates on savings account so frequently.
Liquid funds in comparison are not completely free of risk & returns are not fixed. You may perceive them as low risk-low returns instrument. As they invest primarily in debt instruments, they might be subject to interest rate risk and credit risk. But since liquid funds invest only in short-term (up to 91 days) high quality debt securities, you may not find sharp fluctuations in NAV of the fund.
That said there is hardly any possibility of capital erosion & even returns though not fixed would change gradually and be in a thin returns band. (Say 20-30 bps over a few months). These are the safest form of debt mutual fund investments & returns have been steady (all liquid funds have given 7-7.5% returns in last 12 months). Rightly, liquid fund is perceived as the savings account of mutual funds. Thus not only savings but any short term funds even in current accounts, even for a few days or couple of months can be parked in liquid funds.
Liquid Fund vs Savings Account
Debt Mutual Fund: Duration Funds vs Accrual Funds
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 10 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata. He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’