Liquid fund or sweep-in FD? What should you pick for emergency money

Both liquid funds and sweep in fixed deposits are excellent risk-averse investment options. We help you decide between the two

 Before you begin your investments, ideally it is important to create an emergency fund-  a valuable asset that must be set up in case of a financial emergency.  

It is a reserve that you need at a time of crisis or for unforeseen events, rather than for regular expenses. Spreading your emergency money across recurring deposits, fixed deposits, and liquid funds are ideally the best option among  investors. But if you are unable to spread your funds, which one should you pick? 

Liquid funds:

Liquid funds are a class of debt funds that invest in short-term assured interest providing money market instruments such as treasury bills, commercial papers, high-rated corporate and government bonds. The instruments that liquid funds invest mature within a timeframe of ninety-one days.

"The main objective of liquid funds is to provide safety in the form of capital preservation. It is for this reason that these funds invest in high-rated money market instruments. Hence, liquid funds are considered to be relatively safer than any other class of mutual funds," said ClearTax.

How to choose the right liquid fund
 

After  a torrid time during the high liquidity post pandemic period, liquid funds are back in vogue now with 1-year returns ranging from 6-7% on average.

"A well-performing liquid fund should beat its benchmark as well as its peer funds, but investors must also verify that the fund has done well consistently. This can be checked by looking at its past returns. You can go for a direct fund with a low expense ratio. The returns between the two options are not likely to be too different. But the difference is forward returns versus past returns. The FD guarantees a forward return where as the liquid fund can only advertise its past returns and cannot confirm a fixed rate of future return," said Adhil Shetty, CEO of Bankbazaar.

What is a sweep in FD?

The sweep-in facility offered by banks automatically transfers funds from a savings account into a fixed deposit account when the balance in that savings account exceeds a certain threshold. This feature has been designed to optimize the utilization of the  funds and potentially earn higher interest rates on the excess money that one might not need for immediate expenses.

According to HDFC Bank, sweep-in facility ensures that whenever funds in your Savings Account are running low for a purchase or transaction, the bank will transfer the deficit amount from your Fixed Deposit to your Savings Account without affecting your interest rate in your Fixed Deposit. This can help you in a pinch when there is an emergency like sudden hospital bills, buying a vehicle or any other personal emergency.

"The rate of interest on the sweep-in FD account will be similar to short-term FD rates. The excess amount that is invested through the sweep-in facility will earn the same interest as the FD," said Shetty.

The tenure of the auto sweep-in FD ranges from one to five years, depending on the bank. Investors can state the amount that they want to hold in their savings account and current account, and the rest will be auto transferred to the sweep-in FD account.

"Banks usually transfer surplus money in the savings account to sweep-in FD in multiples of Rs 1,000. However, certain banks also allow transfers in the range of Rs 1 – Rs 1,000 as per the instructions given by the investor.The rate of interest for the sweep-in FD account will be similar to any normal FD and will depend on the term of the FD. The excess amount that is invested through the sweep-in facility will earn the same interest as the FD. Also, it allows investors to earn a higher return than the savings account on the surplus money," according to wealth management platform Scripbox.

How to choose between a liquid fund and a sweep-in FD?
 

Now the choice between the sweep-in facility and liquid funds depends on an individual's financial goals, time horizon, and risk tolerance, as well as the prevailing economic and interest rate conditions.

When liquid fund is better

""Liquid mutual funds invest in high-quality government and corporate bonds maturing within 91 days. These funds provide marginally better returns than fixed deposits and are suitable for those looking to park a lumpsum amount for a short tenure safely, say, to make a down payment for a flat three months later," said  Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth

For example, if you have received an annual bonus worth Rs 10 lakh from your employer, and you had already planned to buy a house, you can park it in a liquid mutual fund while your paperwork for the down payment is finalized. However, withdrawal from a liquid mutual fund takes 1-2 working days.

When sweep in is better?

"We may not have such a long window to act in some emergencies, such as medical treatment. Thus, a sweep-in FD is a better instrument to park emergency funds. If you have Rs 10 lakh in a sweep-in FD and need Rs 8 lakh for an urgent medical condition, you can immediately withdraw this amount online and continue to earn the same interest on the rest of the amount. Unlike a traditional FD, there is no penalty or change in interest rates for premature withdrawal," added Kulkarni.

Take risk into account 

"Those with moderate risk tolerance can look at investing in liquid funds, as it offers them an opportunity to get higher returns than sweep-in facility and opt for flexible withdrawals with maturity up to 91 days. On the other hand, as sweep-in facility initiates an investor into fixed deposit investment, one needs to keep the funds invested for a longer term to get higher returns. The returns depend on the terms of the sweep-in deposit.  Sweep-in facility offers better returns one if one keeps substantial idle balance in her/his savings account," said Aditya Damani, Founder at Credit Fair Capital.

Advantages and disadvantages of both 

Both liquid fund and sweep in FD serve have their advantages and disadvantages and investors must understand their core requirement and choose accordingly.

Liquid funds offer reliable returns without any premature withdrawal charges though the money is available only on the next working day  after the redemption request. Liquid funds also offer flexibility of holding tenure.

"Sweep in FD allows instant money access anytime however returns may be lesser than what liquid funds offer depending on your bank. Also the sweep in FD rate is not applicable on the amount that you withdraw but on the money that is lying within FD and there is a specific tenor that you have to thus keep your money for," explained - Akshar Shah , Founder, Fixed Invest, another wealth management platform.

Shah believes that for an emergency fund, a sweep in FD would work better than liquid fund for instant access and for otherwise parking of money for short term goal a liquid fund which adds flexibility of holding for tenor or choice is better.

For example, Mr. Sharma requires Rs 100,000 for any emergency and puts in a sweep in FD of 6 months at 7%.

Now Mr. Sharma can enjoy instant access of the money while the money also enjoys a healthy interest rate. If Mr. Sharma requires Rs 20,000  after two months,  then Rs 20,000 earns a nominal interest for 2 months. The remaining 80,000 principal continues at 7% interest rate.

In a liquid fund, while there is no one single fixed return,  it delivers returns daily on the whole outstanding amount.  without you having to necessarily choose any one particular tenor

Hence, Mr Sharma can add 1 lakh in liquid fund of any AMC. Whenever Mr. Sharma requires money, he can put a redemption request for any amount on a working day and money will be credited in his account on the next working day.  He will earn interest daily on his principal and hence will be able to see the outstanding money he has in the fund.

Safety aspect
"Depositors opting for sweep-in facility would be covered under the Depositor Insurance Program provided by the DICGC, an RBI subsidiary. While liquid funds have much lower credit risk than other debt fund categories due to their shorter maturity profile, there have been instances of liquid funds taking riskier credit calls to generate higher returns. Investors who are more flexible in their risk tolerance and seeking to benefit from the expected changes in the interest rate cycle can opt for liquid funds," said Sahil Arora, Business Head, Unsecured Loans, Paisabazaar.

What's in the market right now? 

Currently liquid funds are offering the yield at around 6.9 per cent whereas banks offering sweep-in FD are offering 7% interest rate on average.

According to industry experts some of the top liquid funds in the market are Quant Liquid Direct Fund-Growth Fund, Mahindra Manulife Liquid Fund - Direct Plan - Growth, Aditya Birla Sun Life Liquid Fund Direct-Growth Fund, Axis Liquid Direct Fund -Growth and IDBI Liquid Fund Direct-Growth Fund among others.

"Since theseliquid fund returns are in the range of 6-7 per cent, they  at par with sweep FD's, so there's no real advantage of choosing a liquid fund over them, especially considering that returns from liquid funds are variable versus sweep FD returns that are fixed," said Aniruddha Bose, Chief Business Officer, FinEdge.

What about tax?
Both products carry the same taxation as well. Vipul Jai, Partner,  PSL Advocates & Solicitors explains this: 

For taxation purposes, if the liquid fund is held for more than three (3) years, it is taxed as LTCG (Long Term Capital Gain) @ 20%, otherwise it is taxed as slab rate. On the other hand, the interest earned on Sweep-in FD would be taxed like a regular FD, i.e. at slab rate, however TDS may be applicable beyond a certain threshold amount. Therefore, if the investment period is less than or equal to three (3) years, there is not difference in the applicable tax on liquid fund and Sweep-in FD.

"If your bank offers a sweep facility, you should go for it to optimise your returns on your idle money. Any short-term funds that you can park away without the need for instant access should ideally be invested into arbitrage funds, which also offer similar returns as liquid funds but are more tax efficient. The real impact of potentially higher variable returns only really comes into play for long term goals," said Bose.