Liquid Fund vs Fixed Deposit: What’s the Difference

You have got some extra money sitting in your savings account earning just 3% to 4% interest. You know you should do something better with it, but you are confused about where to park it: a fixed deposit or a liquid fund. Both seem safe, both promise returns, but which one suits your needs better?

Let’s compare both of these on multiple parameters to find which suits your financial needs.

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 more than 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 investment vehicles on multiple aspects.

Compare FD vs Liquid Fund

Compare Return on Investment

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. Their returns range from 6.5% to 7.5% annually, but this keeps changing depending on market conditions, prevailing interest rates and the performance of the underlying securities.

Liquidity

This is where the biggest difference lies. Fixed deposits lock your money for the chosen tenure. If you want your funds before the 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:

• Some fund houses offer instant redemption facilities of up to ₹50,000 or 90% of the investment (whichever is lower), as per the scheme's terms.
• Larger withdrawals might take 1-2 business days.
• Minimal or often zero exit load.

Tax Implications

Interest earned on fixed deposit investments 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).

For debt mutual funds purchased on or after April 1, 2023, all capital gains are treated as short-term capital gains and taxed according to your income tax slab rate, regardless of the holding period, with no indexation benefit allowed.

Risk and Safety

In fixed deposits, each depositor is insured up to ₹5 lakh 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, returns are not guaranteed and can fluctuate depending on the underlying securities and prevailing market conditions.

Minimum Investment and Flexibility

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

You can start investing in liquid funds 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 usually don’t attract any penalty, but are subject to the applicable exit-load provisions. You can add to the investment anytime.

FAQs

Is a fixed deposit less risky than a liquid fund?

Yes, fixed deposit investments are less risky than liqduit funds as they offer guaranteed returns while liquid fund returns are dependent on the market’s performance.

Which is more flexible, FD or liquid fund?

Liquid funds are more flexible because you can usually withdraw money when needed, while investors are charged a penalty if they withdraw their FD investment before the maturity period.

Can I invest in both FD and liquid funds?

Yes, you can use both FD and liquid funds based on your risk appetite and return expectations.