Keep 2 months' expense in savings account, move rest to liquid funds

Instead of chasing past returns, choose a fund with papers of high credit quality

State Bank of India has cut its savings deposit rate from 2.7 per cent to 2.5 per cent. A number of other public and private sector banks have also reduced their savings account rates in recent times. Investors should consider moving a part of the money held in savings accounts to liquid funds.

 

Better returns, minimal volatility 

Liquid funds can offer higher returns than savings accounts.

 

“The yield-to-maturity (YTM) on liquid funds is often significantly higher than the returns on savings accounts,” says Abhishek Bisen, senior executive vice-president and fund manager – fixed income, Kotak Mutual Fund.

 

“Current YTM of liquid funds is in the range of 5.75–5.80 per cent, significantly higher than typical savings account rates, which are around 2.50–3 per cent,” says D P Singh, deputy managing director and joint chief executive officer, SBI Mutual Fund.

 

Kaustubh Gupta, co-head – fixed income, Aditya Birla Sun Life Asset Management Company, is of the view that the YTMs of these funds would broadly be repo plus 25–50 basis points. 

 

These funds have low volatility. “They invest in high-quality debt securities with maturity of up to a maximum of 91 days, so volatility tends to be minimal,” says Chintan Haria, principal – investment strategy, ICICI Prudential Mutual Fund.

 

No minimum balance requirements exist. “There are no charges or penalties, even if your folio balance becomes zero,” says Singh.

 

Quick access 

Redemption from liquid funds typically follows a T+1 cycle. “If you submit a redemption request by 3:30 pm on a working day, your funds will usually be credited to your bank account by 10 to 10:30 am the next business day,” says Bisen.

 

However, payouts get delayed if there is a weekend or a holiday. If you place a redemption request on a Friday, you will receive the money on Monday, the next working day. “If a request is placed on a Saturday, the net asset value (NAV) of Monday will apply and the money will typically be credited by Tuesday,” says Haria. 

 

Some asset management companies (AMCs) offer instant redemption. “Under this facility, investors can withdraw up to ₹50,000 or 90 per cent of the latest value of investment, whichever is lower. The Instant Access Facility is available even on a weekend and holidays,” says Vikash Agarwal, senior fund manager – fixed income investments, Nippon India Mutual Fund.

 

Gupta adds that there is no cut-off time under the instant redemption facility and investors can request money at any time.

 

The NAV applied depends on whether the request is made before or after the cut-off timing. “In case the redemption request is placed before the cut-off time, the same day’s or the previous day’s NAV, whichever is lower, applies. In case the request is placed after the cut-off time, the same day’s or the next day’s NAV, whichever is lower, applies,” says Agarwal.

 

Understand the risks 

Investors need to be prepared for some delays in receiving their money from a liquid fund. “You can’t redeem immediately from liquid funds of all fund houses, unlike savings accounts where you can withdraw money immediately,” says Vaibhav Porwal, co-founder, Dezerv.

 

Money in these funds does not get insurance cover. “Unlike bank deposits, which are insured up to ₹5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC), liquid funds have no such insurance,” says Porwal.

 

These funds impose a graded exit load if you redeem within 1–7 days. “It could lead to loss of a fraction of interest if you withdraw too soon,” says Feroze Azeez, joint chief executive officer, Anand Rathi Wealth. He suggests that investors should ensure they can invest for at least a month.

 

In rare cases, liquid funds can face mark-to-market losses.

 

Taxation is another consideration. Gains from both are taxed at slab rates. However, interest from savings accounts is tax-free up to ₹10,000.

 

Fund selection, ideal allocation 

Instead of chasing past returns, focus on credit quality. “Prioritise funds that invest in highly rated instruments, primarily sovereign debt, T-bills or AAA-rated papers,” says Porwal.

 

Despite the reduction in returns, a savings account still makes sense for truly immediate needs, like daily expenses or unplanned medical bills, due to instant access. “Keep 1–2 months of expenses in a savings account and 3–6 months in a liquid fund,” says Porwal.

 

For investors in the higher tax bracket with a horizon of over 4–6 months, Azeez suggests arbitrage funds over liquid funds, as they enjoy equity-like tax treatment.