Having a healthy corpus of atleast 6 months’ expenses towards emergency funds is always desirable, for it gives you enough cushion towards any unforeseen event in future. However, in absence of much financial awareness, a significant proportion of our surplus cash is parked in savings accounts which generally yield very low returns of 4%, though a few banks do provide you little higher rates ranging from 4.5%-7% to increase their CASA deposits.
For a traditional saver, the savings accounts provide the convenience of anytime withdrawal and hence, turn out to be the best place to park the funds. But with the emergence of financial market, many instruments have emerged offering similar convenience and higher returns. One such instrument matching our needs is liquid fund. These can help us earn better returns from what the savings accounts offer while not compromising much with the liquidity and availability of funds.
What is a Liquid Fund?
Liquid funds are a special category of mutual funds which invest primarily in debt and money market securities with maturity of upto 91 days only. Liquid funds derive their nomenclature from the liquidity they offer for the funds invested since these provide faster redemption proceeds than regular equity or debt mutual funds.
Benefits of Liquid Funds
Liquid funds offer the convenience of liquidity of funds, since there is no exit load irrespective of the period for which funds have been invested i.e. no additional charge before redeeming the invested amount before a stipulated period. Further, the redemption requests from liquid funds are processed faster than other mutual funds. Just place a redemption request before 2 PM and the process is initiated for transfer in your bank account the very next working day. Further, since the liquid funds invest in money market instruments or other securities with residual maturities of less than 91 days, these type of funds carry lowest interest rate risk.
Returns from Liquid Funds
As per the data available, the liquid funds generated an average return of 7.3% over the past one year with returns ranging from 9.0% for the best performer and 5.3% for the worst performer. So, even going by the law of averages, the liquid funds have offered the returns at par with the term deposits rates currently offered by banks while additionally offering liquidity similar to Savings Accounts.
Taxation of Liquid Funds
So, now that you must be quite motivated to invest your emergency funds into liquid funds, you must also be curious to know about the taxation from the returns you get from liquid fund. It is certainly important to classify the income in correct column under Income Tax Returns too. So, while the interest on Savings Account is taxable under the head ‘Income from Other Sources’, the returns from liquid funds will be taxed as capital gains. The tax rate also depends upon the duration for which funds have been invested.
Units of a liquid fund shall be considered as a short-term capital asset where the same are invested for a period of 36 months or less. When you keep the funds invested for more than 36 months, it will attract long term capital gains whenever you sell it. Short term capital gains are to be taxed at the normal rate of income tax, while long term capital gains are subject to tax at 20% (plus surcharge and education cess as applicable) with indexation benefits.
Hence, it can be seen that the taxation of liquid funds is at par with interest from Savings Account in case the funds are kept invested for a period of 36 months or less and it is even more tax friendly in case funds are invested for a longer period.
So, it’s time to #ThinkHatke and get your funds work harder and yield smarter.
Check out the A2Z of Personal Finance here.