Unlocking Liquidity: Why Liquid Funds Outshine Fixed Deposits

Fixed deposits come with an interest rate that is fixed for a defined tenure, offering security in investment but a lack of flexibility. Liquid Funds invest in near-term securities that tend to provide slightly better return prospects. An additional advantage of Liquid Funds is the ability to redeem units at any time, as there is no lock-in period like there is with Fixed Deposits.

Liquid Funds, as the heading suggests, offer complete liquidity of your investment. Fixed deposits have early withdrawal penalties that take away from the interest earned before the maturity date, while Liquid Funds allow quicker investment redemptions without penalties, making it optimal for emergency savings or potential short-term goals.

Taxation plays an important role in calculating the real return on an investment, as interest accrued on Fixed Deposits is added as income and taxed at the investor's respective tax bracket.

In comparison, after 3 years, gains from a Liquid Fund hold eligibility for the capital gains tax rate with possible indexation benefits resulting in lower taxed income. For a high-earning taxpayer, the difference in return could prove significant regarding tax savings.

FDs are sensitive to increasing interest rates. When market interest rates are on the rise, aged FDs with relatively lower rates become less attractive for investment purposes. On the other hand, because Liquid Funds make ongoing changes to portfolios based on the prevailing market environment, fund investments change with market interest rates.

Whereas FDs require complete withdrawal at maturity, Liquid Funds offer systematic withdrawals. This means you have the option to redeem a fixed amount periodically so that you can receive periodic income.

Liquid funds do have an expense ratio, albeit nominal as a charge for managing the fund. On the other hand, they are often the cheapest of all other mutual funds due to their large asset base, leading to volume benefits to ensure that the charges don’t reduce overall returns.

A Fixed Deposit normally depends on one bank's credibility, while Liquid Funds spread out the risk by diversifying into various instruments of different issuers. Thus, any single-asset or issuer-level bias due to risk contributes less than it would have had they invested in only FDs, hence making the portfolio much safer and more stable.

Returns from fixed deposits can sometimes be effective at eroding the value of returns received that are real (inflation-adjusted)/inflation-adjusted returns, especially when the level of interest rates is low. Liquid Funds can generally produce higher returns than Fixed Deposits, thus providing inflation-adjusted growth within tax-efficient structures.