Liquid funds offered by various mutual funds offer a very sound alternative to savings account. The only difference is that you do not have checking facility with liquid funds nor do you have the facility of fund transfer. But if your money is idle for a few days then it makes more sense to park the money in liquid funds rather than keeping it in a savings bank account.

Let us now look at how these liquid funds compare with bank FDs?

How do Liquid Funds compare with bank fixed deposits (FDs)? Technically, they are not comparable as bank FDs have a minimum lock-in period while liquid funds do not have any lock in period. Bank FDs may be theoretically locked in but one can create liquidity on bank FD. For example, it is possible to break your FD at short notice and also take a loan against your bank FD. However, both these involve a cost and that will reduce your overall returns. Why this comparison becomes interesting is for a different reason altogether.

Bank FDs used to offer much higher returns in the past. But, since January 2015, the RBI has been consistently cutting the interest rates. As a result FDs are also yielding just about 7-8% returns today. With liquid funds also offering similar rates of return, liquid funds may be emerging as a strong alternative to FDs. Like FDs, liquid funds are also safe and secure. They offer almost similar returns on an annualized basis. But the big advantages that liquid funds offer are liquidity and easy entry and exit with very minimal cost. Also in terms of tax treatment, liquid funds are more favourable than bank FDs. For example, interest earned on FDs is taxed at your peak rate of tax at 30%. On the other hand, liquid funds being mutual funds do not attract any tax on dividends paid out. In the current scenario, this makes a strong case for liquid funds over bank FDs, as a means for parking funds. However, if you do opt for a dividend plan of these liquid funds, you will end up paying 29.12% as dividend distribution tax (DDT), each time the fund declares dividends. That is something you need to be cautious about and ideally prefer to keep the money in a growth plan and use systematic withdrawal plans (SWPs) to draw regular money.