Comparing Liquid Funds vs FD: Which Offer Better & Much Higher Returns?

Fixed deposits (FDs) are considered one of the most risk-free investment options and have been a favourite among investors for decades. While the returns are fixed and assured, they tend to be much lower than other instruments, such as stocks or mutual funds. Investors looking for low-risk investments with high liquidity and slightly higher returns can also park their funds in liquid funds.

Both liquid funds and FDs invest in a spectrum of debt instruments like money market instruments such as treasury bills, government bonds, and certificates of deposits. However, liquid funds carry some extra risk but offer slightly higher returns, although not as high as equity mutual funds.

In this blog, we shall understand the similarities and differences between liquid funds vs FDs and how to decide when investing in these two instruments.

What is a Fixed Deposit? 

Fixed deposits are fixed-income bank deposits where you put away a lump sum for a fixed period, ranging from seven days to 20 years. Fixed deposits typically yield higher interest than a savings bank account. They earn a fixed rate of return over the tenure. When the interest is paid out at regular intervals – quarterly, monthly, bi-annual or annual – it is known as a non-cumulative fixed deposit. In contrast, a cumulative fixed deposit is one where the interest is paid at the end of the tenure, along with the principal.

Banks, deposit-taking non-banking financial companies (NBFCs), and the post office offer fixed deposits. The main advantage of fixed deposits is that they offer assured returns at a predetermined interest rate, time frame, and intervals. In addition, they present lower to negligible risk and are a flexible investment option where you can open a deposit with a minimum amount of ₹100.

Fixed deposits usually offer interest rates between 2.5% to 8.5%. You can make a premature withdrawal by paying the penalty.

While fixed deposit returns are typically taxable, some banks offer five-year tax-saver FDs under Section 80C of the Income Tax Act.

Also Read: Experience financial growth with unmatched Bajaj Finance FD Rates

What are Liquid Funds? 

A liquid fund is a type of debt mutual fund that primarily invests in securities with a maturity period of only 91 days. These securities include treasury bills issued by governments (also known as T-bills), short-term government bonds, commercial paper (CPs), bank term deposits, and certificates of deposits (CDs), among others. Liquid funds are relatively low-risk as compared to equity-based and hybrid mutual funds. However, they carry an element of risk, as the returns are not fixed or assured.

On the other hand, liquid funds, as the name suggests, are ideal for individuals looking to park surplus funds for a brief period, as they offer high liquidity and capital protection. For instance, if you have some funds that you want to invest in buying a home, launching a business, or buying a car, after a few months, you can put them away for safekeeping into a liquid fund. Liquid funds offer higher returns than savings accounts and sometimes more than fixed deposits with minimal risk.

Liquid funds are not tax-free and do not offer any tax deduction benefits. Profits earned on a liquid fund redemption before three years will be added to your income and taxed as per your income tax slab. If you hold liquid funds for over three years, the profits are taxed as capital gains at the rate of 20%, making them.

Read More: Liquid Mutual Funds – What Are Liquid Funds | Risk, Returns & Benefits

Why you should invest in FDs and Liquid Funds

Diversifying your investment portfolio by balancing the risks with rewards is essential. Putting all your capital into equity-based instruments such as stocks and equity mutual funds can drive high returns. But it also leaves your portfolio vulnerable to the risk of capital loss when the market is volatile. On the other hand, if you invest around 20 to 25% of your portfolio in debt instruments, you are assured of a diversified portfolio.

Also Read: Equity Market in India: Definition, Types, Benefits & Working

Difference between Liquid Funds and FDs 

Here’s a snapshot of the key differences across various parameters: 

Also Read: Why Debt Mutual Funds are better than Fixed Deposits

How to choose between fixed deposits and liquid funds?

As mentioned above, both FDs and liquid funds have a risk-to-return ratio; it depends on your risk ability to choose between the two. Here are a few points to consider before choosing between the two.

Who should invest in FDs?

For investors who want to invest in instruments with no risk and want to earn an average return, Fixed Deposits are ideal for them. DICGC provides insurance coverage of up to ₹ 5 lakhs per investor. However, if you are opening an FD account with an NBFC, checking the corporation’s credit rating before investing is suggested.

FDs are an excellent long-term investment option with higher returns than the savings account.

Who should invest in Liquid Funds?

Liquid funds are less riskier than equities but more from FDs. Investors who want to invest for a shorter term with a moderate risk appetite can invest in liquid funds. The goal is to provide capital protection and liquidity to investors.

The returns on Liquid funds are not assured but are better than FDs. Liquid funds are best for you with a low to moderate risk appetite.

Final Thoughts

Liquid Funds are an investment that puts your money into short-term loans and can be withdrawn whenever needed. The maturity period of liquid funds is 91 days.
Fixed Deposits allow you to invest your money and earn good interest on it safely. Fixed deposits offer an investment period ranging from 7 days to 20 years.
Fixed Deposits and Liquid Funds are safe ways to grow your money with little risk.

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