Most people, out of habit, keep their money parked in savings bank account. Putting money in a bank account actually erodes its value if you consider the inflation rate. While most banks offer an average interest rate of 4%, the inflation rate grows at an average rate of 6 percent or more. With this low rate of interest, banks earn much less for you compared to the rising costs in the economy.
It is recommended that if you want to earn substantial amount of wealth, you should invest in equities over a long-term basis through equity mutual funds. Having said that, if you want to invest for a short period of time but earn more returns than your bank would give, you should consider liquid funds.
Liquid funds are similar to savings bank account, when you consider the liquidity and safety aspects. Additionally, these earn higher returns that a savings bank account would. Liquid funds predominantly invest in money-market instruments like commercial papers, treasury bills, certificates of deposit, etc. The ‘residual maturity’ or the remaining time before the repayment of these instruments expire, is not more than 91 days.
The top liquid funds or money market funds earn returns as high as 8% per annum which is higher than the prevailing inflation rate, and definitely better than what the bank would give. The safety factor in liquid funds come from the fact that these schemes usually invest in government based papers and AAA-rated instruments. Liquid funds do not have any exit loads. On a post-tax basis, liquid fund are always above the returns from a savings bank account.
Previously, liquidity was the reason that most people would shy away from investing in liquid funds. Back then, it would take three days or so, to get the money back into your account. But in the present-age of e-banking, you can get the money back into your bank account, the very next business day. So, if you send in your redemption request before 3 PM on a business day, the money gets credited into your bank account the next day. If the request is after 3 PM, the money gets credited to the bank account the second business day. Investing in liquid funds is extremely convenient, where you can both invest and redeem your money through net banking, debit card or SMS. To sum up, banks offers the highest liquidity, where you can withdraw your money instantly, but if you can wait for one day, then it is advisable to park your money in a liquid fund to benefit from higher returns.
Liquid funds also offer better liquidity than a fixed deposit, another conventional mode of investment. In fact, there is a penalty amount charged for premature withdrawal in case of a Bank FD. It is advisable to go for the growth options in liquid funds for tax efficient return.