Individuals looking for a safe option in mutual funds that offer low risks and high returns may consider parking their money in liquid funds. The investment option puts money in market instruments such as commercial papers, treasury bills, and high-rated corporate and government bonds. Liquid funds have recently gained popularity as a savings instrument and stand in stark contrast to other plans like fixed deposits (FDs).

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Here is everything you need to know about the scheme and how they compare to FDs.

How do liquid funds work?

Liquid funds are debt funds that invest in fixed-income instruments which have duration of up to 91 days or longer if desired by the individual. The fund manager puts the money in high-quality debt securities that aim to deliver better returns. The objective of the scheme is capital protection and liquidity. The funds offer around 7 to 9 per cent returns, which is much higher than FDs.

The net asset value (NAV) of a liquid fund undergoes little volatility since the duration is 91 days or less. This option is especially viable for creating an emergency fund. For investors who want to raise money in a timeframe of three months, liquid funds provide a chance to maximise their savings.

How do fixed deposits work?

Fixed deposits offer assured returns to risk-averse investors. These investments work on the principle of deposits in bank accounts. The interest on the FD is accrued either on a periodic basis or at the end of the term. The rate of return will be less affected by market conditions compared to other schemes, including liquid funds. It may either remain constant throughout the term or be changed by banks after monetary policy changes by the Reserve Bank of India.

Which is more beneficial- fixed deposits or liquid funds?

Risks and returns: If one looks at the risks offered, fixed deposits are a safer option. Liquid funds are typically riskier and more volatile. In terms of returns, liquid funds are more advantageous.

Taxation: If an investor sells the liquid fund units held for less than three years, it will be taxed under short term capital gains tax. The tax will be applicable at 15 per cent plus cess and surcharges. On the other hand, if the fund is held for over three years, then it will incur long term capital gains tax of 20 per cent after indexation. On the other hand, gains on fixed deposits will be taxed under income from other sources. TDS will be applied above certain thresholds. Taxpayers can also get deductions under section 80C for tax saving FDs.

Investment tenure: Liquid funds are a viable option for both short term and long term investors. FDs will be beneficial only if used for a longer duration.

Overall, figuring out which investment option is better depends on the needs of the individual, their appetite for risk and the duration of the investment.