Banks reducing interest rates on Savings account – what should you do?

On 25th May, 2020 Kotak Mahindra Bank slashes interest rate by 0.50 percent on savings deposits. This is second time in month now that bank has cut rate. You can see deposit rates across the banks are dipping due to interest rate lowering by RBI and banks don’t have lot of options as people or companies not coming forward to take loan due to COVID situation. Even SBI now offers an interest rate offering of as low as 2.75 per cent on the savings bank deposits. This is just a hint at the possibility of lowering the rates in near future.

So what should you do as a retail investor heavily relying on saving account to manage day to day expenses. Is it really beneficial to invest in Liquid Funds instead of keeping money in Savings Account. Are Mutual Fund distributors selling a product just for commission or is it really better. Are Liquid funds as safe as Saving Account. Lets find out if there is any hera pheri or we will really benefit with this. I have also included a calculator which you can use to get rough idea of benefit before taking a decision. But before we go to calculation, let us understand this better.

I don’t think we need any introduction of Savings Account. The first thing that any person does in his financial life is to open a Savings Account. Most of the time our first saving account is opened in our childhood by our parents. They use it to save money that we get during birthdays, Diwali, prizes, etc. I still remember excitement of my first account opening. My father opened it for me in Saraswat Co Operative bank. I was so excited looking at balance increasing in my own passbook every year. Then I practiced, practiced and practiced to create my signature – my financial authority. There will be hardly anyone with descent income who does not have savings account. We use it as our first line of expenditure. Has time come to change that.

If you speak to any mutual distributor, he would talk to you to keep money in liquid fund. Is he selling his product or it is really helpful. Generally we are not disciplined to move extra money to some investment like FD, mutual fund, etc in timely manner. So significant money that we earn remains in saving account for many days of a month earning 3 – 4 %. This happens every month and what looks like trivial amount, stays idle throughout year. Today let us see if change that, will get us better returns compared to savings account. And how much is benefit? Will it be really worth all the effort. And most important, can we calculate benefit before making change.

It all started when Babulal, Raju and Shyam came to my office inquiring about liquid fund. They travel together daily to work in Mumbai local from Borivali to Dadar. Someone in train told them how liquid funds are much better than keeping money in savings account. He also showed them some mobile app which can instantly transfer money back to their saving account in minutes. Naturally they wanted to know if its really good. Who doesn’t like that extra money without any work. So should they move idle money to liquid fund instead of keeping it in saving account.

1. We know Saving Account but what are these Liquid Funds baba? Babulal started.

I knew why Babulal was so excited. So far he knew only one liquid and he was very excited by name of these funds – Liquid Funds. I knew my answer is going to disappoint him. Liquid funds are type of mutual funds which are invested in debt instruments which have high liquidity. Liquidity means how easily one can get back money.

Say if you invest in real estate, and if you want to sell it and get money, it may take months to complete transaction. That is example of illiquid asset. Whereas if you have some money in say savings account, you can get it in minutes by visiting bank or ATM. That is a liquid asset. Since Liquid funds invest in assets which are or short duration maturity and fast to get money back from, they are called Liquid funds. They invest in high quality debt instruments with maturity duration less than 3 months – mainly money market instruments.

In simple language, money would get invested in such debt instruments which have maximum maturity of three months . Due to low duration, they are not impacted significantly by changes in interest rates. You might have heard that as interest rate increases, returns from debt funds goes down and vice versa. Liquid fund is a sub type of Debt Fund. But duration of assets of liquid funds, is so low (just three months max) that overall impact on returns is very minimal. If you want to know about debt funds, you can read ABCD of Debt Funds.

2. You said Liquid Funds invest in market? Shyam jumped in

Where does Liquid Fund invest
Liquid FUnd kahan invest karte hai re baba

Yeah. But its money market instruments. Not shares or stock market. Some of money market instruments are Certificate of deposits (CD), commercial paper(CP), treasury bills. These are generally issued by either banks or commercial financial institutes or government for short term needs. Don’t worry if you did not understand these. Even Babulal, Shyam and Raju did not. You can see their expression in photo. All you need to understand is – no money is invested in stocks or even long term debt. So risk is very less.

3. So is Liquid Fund totally safe like Savings account?…Raju wanted to be very sure

Safety of Liquid Funds
Are Liquid Funds safe?

Simple answer – No. None of the mutual funds are with zero risk. So even liquid funds are not entirely risk-free. But they carry very low risk. NAV of liquid fund doesn’t fluctuate a lot as the underlying assets mature in short term. One should remember basic rule of life – no risk, no returns. Liquid Funds are one of the least risky category in mutual fund industry. Theoretically, there could be downgrade of underlying security impacting NAV. But if you see portfolio of any liquid fund, money is diversified across many different instruments. Money is well distributed and impact of any one single instrument getting downgraded on overall fund is very low.

4. Return kitna milega re baba….typical of Babulal

One can expect around 6 – 7 % returns in liquid fund but these are not guaranteed fixed returns. Based on liquidity in market, it can go little up or down but one can expect to get couple of percent more than standard savings account. I showed them returns from top liquid funds here. When you look at returns, don’t compare them with Equity. These are low risk – low return mutual funds suitable for parking money for short time.

5. Anything else that we should know?…Shyam was not impressed with returns of Liquid Funds

You need to know about Tax treatment. In Savings account, you get interest. In liquid fund, your returns are called capital gains. The rate of tax is based on how long you stay invested. If you are using liquid fund as alternative to savings account, you will be withdrawing money frequently as and when needed. Since period will be less than 3 years, its called short-term capital gains (STCG). STCG from liquid funds are added to your income and taxed according to your income slab. So Raju will need to pay 30% and Shyam may be 20% as per their highest tax bracket.

STCG on Liquid Funds

Let’s not discuss about LTCG today as that is if you hold fund for more than 3 year. But then you have better options like FMPs if investment period is more than 3 year.

6. To ab hum kare kya? Raju came to the point

See, any mutual fund is for specific needs and it will suit someone and may not suit other. Liquid funds are not different. They may earn 6 – 7 % but you will need to pay STCG if you use money for regular expenses. Saving account earns around 3 – 4 % interest but government gives some tax exemption on interest. For Raju and Shyam who are not senior citizens, section 80 TTA provides deduction of Rs. 10,000/-. Babulal who is senior citizen will get upto Rs 50,000 under section TTB. So we need to calculate who will benefit based on how much money one keeps in savings account, tax bracket and if person is Senior citizen. Babulal jumped from his seat now “To calculate kar na re baba. Jaldi se bata kitna bachega.?

7. Calculator – Liquid Fund vs Saving Account

Calculator - Saving Account Vs Liquid Funds
Calculate yourself

One can use this calculator to get some rough idea of benefit of liquid fund vs savings account. I have not used investment amount to show benefit. This is because purpose is mainly to compare with Saving account. In saving account, our salary gets deposited, then we withdraw some amount after few days, later we pay bills as and when due, we have some SIPs on some dates etc. So money is not fixed throughout. It keeps changing day by day. So how can we compare now. Idea is to assume your behavior does not change even if money is in saving account or liquid fund. You spend or invest or deposit money as before.

You will need to be aware of interest you got from Savings Account in last one year. You can easily find it from your bank statement or passbook. Calculator assumes your financial behavior will remain similar this year as well. Then it will calculate how much could you get in liquid fund for same behavior. Next it will calculate post tax returns in both cases based on your tax bracket and if you are Senior citizen. Below is what we found for my friends with saving interest rate as 3.5% and Liquid Fund return as 6.5%.

NameTax BracketSr. CitizenPre Tax
Saving A/c interest
Post Tax
Saving A/c interest
Pre Tax
Liquid Fund returns
Post Tax
Liquid Fund returns
Babulal5 %Yes5,500/-5,500/-10,214/-9,683/-Switch to Liquid Fund
Shyam20 %No8,500/-8,500/-15,786/-12,502/-Switch to Liquid Fund
Raju30% No4,500/-4,500/-8,357/-5,750/-Neutral. No significant difference
Savings interest vs Liquid Fund Returns comparison table
Better returns - Happy
Happy when one earns more

You can see most cases you one can earn better post tax returns in Liquid Funds. One more observation, if you are in lower tax bracket, benefit is high. You can too check your own benefit using the calculator. Based on that figure, you can decide if its good to move to liquid fund or just stick to straight simple saving account.

If you decide to go for Liquid Funds, I suggest avoid regular plans. Liquid Funds are very straight forward and selecting one does not need lot of research like in Equity or other debt Funds. You can select top rated Liquid Fund from here. It should save you some commission without any significant risk. You can go for any direct mutual fund platform of your choice. I use Kuvera. You can read my review here.

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