Liquid mutual funds to be more favorable than savings account, Icra says

The savings account rate is at its lowest making it one of the most unfavorable financial instrument to park money. However, it can be an opportunity for other products to grow. 

One such product which is the immediate peer savings account when it comes to liquidity and flexibility is Liquid Mutual Funds. 

ICRA in its research report titled "Opportunity for mutual funds to sell low-risk products to capitalise on savings rate cuts" said that as the private banks are slashing the savings rate, it has created an opportunity for liquid mutual funds to tap into retail savings, by providing an avenue for parking surplus liquidity while earning a premium over savings rate. 

Liquid funds are short-term debt mutual funds where an investor has the option to park one's fund for few days or months and earn returns for the holding period as per market rates. 

According to research agency, the liquid funds, which offer the advantage of easy accessibility at the time of maturity and easy redemption, are expected to gain prominence as an alternative tool as retail investors also increase usage of the available benefits of liquid schemes.

"The growth in the individual investor base for mutual funds had hitherto driven the growth in equity assets under management (AUM) while the individual investors’ interest in the liquid schemes was limited. The cut in savings rate below 4% may result in emergence of liquid mutual funds as a direct alternative to savings deposits and lead to greater individual investor participation in this asset class," ICRA said.

If we look at the calculation, putting money in liquid funds at this moment can give you 78% more returns than that by savings account. 

For instance, you deposit Rs 10 lakh in savings account and the same amount in Liquid funds. At present rate of interest in savings deposit is 3.5% while liquid funds' is 6.25%. 

According to ICRA calculation, the annual return by savings deposit will be Rs 35,000 while by liquid funds will give you Rs 62,500. Which means 78% more returns given by liquid funds. 

Further, if you look at Income Tax rate, in case of savings account, the rate depends on tax slab and tax rebate on interest up to Rs 10,000. However, in case of liquid funds, the tax rate depends on the short term capital gains which decides the tax slabs. 

Considering income tax rate at 30%, which will be Rs 7,500 in case of savings account and Rs 18,750 in case of liquid funds. Even then, post tax return by savings deposit will be Rs 27,500 while by liquid funds would be Rs 43,750, which is nearly 60% more. 

Karthik Srinivasan, Senior Vice President and Group Head - Financial Sector Ratings, ICRA Limited said, “Liquid schemes have reported annualised returns in the range of 6.5% to 7.0% over the last one year; the returns have however moderated to 6.25% to 6.50% over the last five months on the back of declining repo rates. These schemes have provided 2.75% to 3.00% higher pre-tax returns, on an annualized basis, than savings accounts."

With the arbitrage between liquid mutual funds and savings rate and that between liquid mutual funds and bulk deposit rates likely to continue, the pace of incremental inflows into liquid mutual funds is expected to increase over the near to medium term, the research agency added.