Liquid Fund vs Fixed Deposit: Understanding the Difference

What is a fixed deposit?

Through a fixed deposit (FD), you give your money to a bank or a Non-Banking Financial Corporation (NBFC) for a fixed period. This period could be 7 days, 1 year, 5 years or even 10 years. The bank or NBFC pays you a predetermined interest rate and at the end of the tenure, you get your money back with the interest earned.

What is a liquid fund?

A liquid fund is a type of mutual fund that invests your money in very short-term debt instruments like treasury bills, commercial papers and certificates of deposit. These investments generally have a tenure of 91 days.

In a liquid fund, you can put money in and take it out quite easily without any exit load, usually within a day or two.

Let's compare the two on multiple parameters

Comparing Returns - FD vs Liquid Fund

Fixed deposits offer a guaranteed rate of interest that is set at the time of investment. Currently, most banks offer 6% to 7.5% for regular FDs (an additional 0.5% to 0.75% for senior citizens)

Your return is locked in from day one. If you invest at 7%, you will get 7% regardless of what happens in the stock market or economy.

Liquid funds don't guarantee returns. They currently offer returns ranging from 6.5% to 7.5% annually, but this keeps changing based on market conditions.

Last month, a liquid fund might give 7.2% returns, this month, it might be 6.9%. The difference isn't huge, but it's variable.

Liquidity

This is where the biggest difference lies. Fixed deposits lock your money for the chosen tenure. If you want your funds before tenure, you might have to bear a penalty of 0.5% to 1%.

Liquid funds offer much better liquidity. You can withdraw your money at any time, usually with these conditions

• Many fund houses process withdrawals up to ₹50,000 or 90% of investment (whichever is lower) within 24 hours
• Larger withdrawals might take 1-2 business days
• Minimal or often zero exit load

Tax implications

Fixed deposits

Interest earned is added to your income and taxed as per your income tax slab. Additionally, banks deduct 10% as tax deducted at source (TDS) if your interest exceeds ₹40,000 in a year (₹50,000 for senior citizens)

Liquid funds

If you redeem within 3 years, gains are taxed as per your income tax slab (short-term capital gains). If you stay invested for more than 3 years, you pay 20% tax with indexation benefit (long-term capital gains). Indexation reduces the tax burden and no TDS is deducted

For most people using these for short-term parking (under 3 years), the tax treatment is similar.

Risk and Safety

In fixed deposits, each depositor is insured up to ₹5 lakhs by the Deposit Insurance and Credit Guarantee Corporation (DICGC)

Liquid funds are relatively safe but not risk-free. In extreme market stress, there could be temporary losses. However, over any reasonable period, liquid funds have rarely given negative returns

Minimum investment and flexibility

Fixed deposits

Most banks require a minimum of ₹1,000 to ₹10,000. You decide the exact amount and tenure upfront. You cannot modify either the amount or tenure. Also, partial withdrawals are not allowed

Liquid funds

You can start with as little as ₹500 to ₹5,000, depending on the fund. Also, you can add or withdraw money from the total invested corpus as per your requirements. Withdrawals don’t attract any penalty. Can add to investment anytime.