Liquid Funds: Risk Factor of Liquid Funds

Though the portfolio of liquid funds comprises of short –term deposits, government securities and money market instruments, they cannot be considered as totally risk free. This is because liquidity patterns and short term interest rates of the government change, sometimes on a daily basis, thereby making the fund susceptible. Such interest rate changes though have a low impact on the fund. Before investing do look into the reputation of the fund house and the past performance of the scheme over a longer period with appropriate benchmarks.

Bank Accounts versus Liquid Funds
Here is a quick comparison between bank accounts (fixed deposits and savings accounts) and liquid funds.

Tenure: Savings accounts do not have any specific tenure. Fixed deposits could be kept for a long tenure. However short tenures of up to a week are generally not possible for FDs (or allowed only for higher amounts), whereas liquid funds comes with very short tenure and even a day is possible.

Returns: Fixed returns plus principal is guaranteed in FDs and Savings Account, where in liquid funds, returns are not guaranteed and it entirely depends on market movements.

Tax: In FDs and Savings Account, interest is taxed as income. There is also a Tax Deduction at Source on the interest earned. In liquid funds, there is Capital Gains tax and Dividend Distribution Tax on the income earned.

Pledging: Fixed Deposits could be pledged as collateral easily and liquid funds are not very easy to pledge as collateral.

Interest Rate: In FDs, once decided, interest could be locked for the tenure of the FD. In liquid funds, interest rate fluctuates and is determined by market movements.

Liquidity: Fixed Deposits could have penalties for premature withdrawal. In liquid funds, there are no such penalties if redeemed post lock in period.

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