Don’t depend too much on Savings account
For the last 2 weeks, you are seeing full page advertisements by some banks announcing the increase in Savings Bank account interest rate. While RBI allowed banks to fix their own interest rates, most of the small banks became very aggressive to attract customers with higher rates. Some banks are offering upto 6% now.
Why we keep money in Savings Bank Account?
- We want to keep some reserve money to meet any emergencies.
- When we are holding cash while waiting for some good investment opportunities.
If we are holding more cash in savings bank account, we are losing on the investment returns, because SB account offers the lowest return. Always keep the necessary amount only in the SB account and keep the balance invested.
Liquid and Liquid plus Mutual Funds – better than SB Account
Liquid funds and liquid plus funds are better option than SB accounts. These funds invest your money in short term debt instruments like certificate of deposit, Commercial Paper, Term deposit, debentures etc. All are debt instruments which will offer returns in line with the prevailing short term interest rates.
In Liquid funds, the money will be invested in above debt instruments with less than 91 days residual maturity. In liquid plus funds the period of investment will be slightly higher. They have very low fund management charges. There is no entry load and exit load in liquid funds. Some liquid plus funds have small exit loads (0.25% – 0.5%), if you redeem within 90 days of investment.
Higher returns than SB account.
Liquid funds and liquid plus funds have delivered returns around 8% in the last 1 year. Given the Government’s borrowing programme, the liquidity in the system is expected to remain low, which will ensure that the short term rates remains firm. The government is borrowing from the financial market to fund it’s widening deficit and this will ensure higher interest rates.
While interest rates on savings deposit are guaranteed, the returns from these funds are not guaranteed. But the above factors will make it attractive in the current market conditions.
Liquidity in these funds
While SB account offer liquidity anytime using the ATM card, these funds offer liquidity in one day. If you redeem the units today, the amount will be credited to your account in the next day. Now, you can do these investments and redemption online to ease the process.
Please see the following chart to see the 1 year return on select liquid/liquid plus funds for the last 1 year.
|Liquid Funds||1year return as on 16th Nov. 2011||Expense ratio|
|Birla Sunlife Floating Rate Short Term||8.61||0.36|
|DSPBR Liquidity Regular||8.48||0.51|
|Templeton India TMA Regular||8.19||0.35|
|HDFC Cash management services||8.62||0.36|
|Liquid Plus Funds (Ultra Short Term Bond Funds)|
|Birla Sunlife Savings Retail||8.64||0.32|
|DSPBR Floating Rate Fund||8.27||0.84|
|Templeton India Ultra Short Term Bond Retail||8.77||0.65|
|HDFC Cash Management Treasury Adv. Plan Retail||8.4||0.59|
It is more tax friendly
While, you have to pay tax on your bank interest income, as per your slab rates, the dividend from these funds is tax free. But there is a dividend distribution tax paid by the Fund house. The rate of dividend distribution tax is 13.52% for liquid plus funds and 27.03% in liquid funds. This will be ideal way to park money especially for those in the 30% tax bracket. It is better to opt for dividend reinvestment option to keep the full money invested.
If you opt for growth option, the short term capital gains will taxed as per your slab rate. The long term capital gains will be taxed at 10% without indexation or at 20% with indexation. It is better to opt for growth option, if your investment duration is 1 year or more. Otherwise, dividend reinvestment option will be tax friendly.
You should have some contingency fund to face any emergencies in life. Keep some amount as cash at home and keep the balance in bank account/liquid fund. Depending on your requirement, you can bifurcate between SB account and liquid/liquid plus fund.
After all, 8% return with 1 day liquidity is always better than 4% in SB account.