People often give out a lot of savings tips when it comes to investing. Very few can compare two options and distinguish them thoroughly via solid parameters.
The article about the main parameters that help compare a savings account and mutual funds.
Tax benefits
The interest incomes from a savings bank account are tax-free up to Rs. 10,000. Therefore, one can park up to Rs. 2.85 Lakhs in savings account at 3.5% without worrying about tax. The limit shall be less if one uses a savings account that offers higher interest.
Tax on liquid funds depends on the holding period. Liquid funds continue to hold their advantage if the holding period exceeds 3 years and the post-tax returns work out to be around 5.59% which can be compared to the interest offered by the best savings bank account. However, if one is forced to withdraw before 3 years, the post-tax returns can fall to 4.15% for individuals in the highest tax bracket.
Risk
Liquids come with very low risk. The risk is so small that it can be almost compared to a savings bank account. However, it is essential to understand that investment in mutual funds in general, and liquid funds in particular, comes with market risk.
Based on market circumstances, the Net Asset Value also changes.
The Savings bank account generally carries no investment risk at all. Thus, it subsequently affects the interest which is very low.
Returns
From the returns perspective, savings accounts come with a low rate of return. Post-demonetisation, banks have significantly lowered the interest rates on savings accounts.
Banks are now offering an interest rate which is as low as 4% on an account balance up to Rs 1 lakh. For the ones who maintain balance above Rs 1 lakh, differential interest rates. Except for small investors, it is difficult to go for such an opportunity.
For a person falling in the highest tax bracket, the post-tax returns on savings account would be around 2.8%. Such a performance is inadequate to counter inflation or for wealth accumulation. Hence, to make the best use of short-term funds, liquid funds are a better alternative.
On average, returns generated by Liquid funds are in a range of 7% to 9%. Considering a tax rate of 30%, the post-tax return would be around 5-6%, which is quite higher than the savings account.
Immediate cash needs
Investors need to consider liquidity when parking their contingency fund. A savings account is the most liquid instrument available to people. Several liquid funds also offer mobile app-based instant liquidity facility where the money comes to your account within a few minutes of redemption. However, you can only redeem up to Rs 50,000 per folio per day.
Since the majority of banks don’t charge a strict penalty for breaking FDs—they usually offer a slightly lower interest—you can keep the contingency fund in fixed deposits as well. Another way is to begin a fixed deposit with a sweep-in facility connected to your savings account. Remember, the short-term capital gains from liquid funds and the interest from fixed deposits are taxable.
Since there’s no one option-suits-all, there’s no winner in this debate. Depending upon your requirements, and by analysing the above factors and investment tips above, choose the option that best suits you and your finances.