The Reserve Bank of India (RBI) recently announced a hike in the interest rates on savings bank accounts. That must have made bank customers happy as most of them leave large amount of money lying in savings accounts.
Sure, they will earn half-a-percent more on savings bank accounts now. However, the moot point is: Does that make the savings account the best place to keep your funds, which will be idle until they are spent or invested?
Savings bank account
Your salary goes straight into the savings bank account. Your housing EMI devours a large part of it. Then the checks you have issued for your credit card payments, utility bills, SIP and so on eat more into it. The balance amount gets accumulated in the savings account month after month.
That is the story of a typical savings bank account, which offers 4% as interest to the savers. The interest is calculated on the daily balance in your account. Earlier, the interest was calculated on the lowest amount in the bank account between the 10th of every month and the last business day of the month. The interest is paid to you at the end of the quarter or half year. That means you earn more money now on your savings account than what you got a year ago. But does that still make savings account the best place to park your idle funds?
Liquid and liquid plus funds
One of the biggest advantages of a savings account is liquidity. You can take the amount whenever you want. But there are avenues that offer better returns than savings accounts, without affecting liquidity much. They are known as liquid funds.
Liquid funds are open-ended money market mutual fund schemes that invest in call money market and other fixed income securities with a maturity period of less than 91 days. Liquid plus funds, also known as ultra short-term bond funds, are debt mutual funds where the fund manager invests in securities which may include instruments with more than 91 days’ residual maturity. The yield is generally higher for instruments with longer term. Naturally, inclusion of instruments with more than 91 days to mature boosts the return of liquid plus funds.
The fund manager puts liquidity and safety as the basic tenets while constructing the portfolios of these funds. This makes these funds a safer place to park your money. The liquidity needs of investors are not at all compromised. For, all redemption requests submitted and time-stamped before the cut-off time, the payouts are made the very next day – this is also known as redemption on T+1 basis.
How do they stack up?
You can compare the post-tax returns of both these options – savings bank account and liquid and liquid plus mutual funds.
“The interest rate of a bank’s savings deposit account is 4%. Ultra short-term funds offer a higher returns,” says Joydeep Sen, senior vice-president, advisory desk-fixed income, BNP Paribas Wealth Management.
“If we look at it on a post-tax basis, returns from ultra short-term funds are even better. The dividend distribution tax for ultra short-term funds stands at 13.5% for individual investors, whereas the interest payable on savings bank deposits is taxed at the marginal rate of tax – for those in the highest slab, it is 30.9%,” he says.
According to Value Research, a mutual fund tracking agency, liquid funds offered 6.75% and liquid plus funds returned 6.82% over one year. If we look at one-week returns, both the fund categories offered 0.16% returns. In the current interest rate scenario, liquid funds score over savings bank accounts. But for how long will this be the case?
Recently, the Reserve Bank of India came out with a discussion paper on deregulation of interest rate payable on a savings bank account. A chart in the discussion paper throws light on how savings bank account interest rate and other key rates have been in the recent past. It is clear that the money market offers better returns for very short-term investments than the returns offered by the savings bank account.
Barring for a short period of a couple of quarters in 2009, the interest rate on a savings bank account has remained lower than the weighted average call rate. “The low money market returns were an outcome of surplus liquidity in the system as RBI, in response to the global crisis, had cut key rates in the second half of 2008,” points out a credit analyst with a fund house.
The money market rates are expected to remain high as the economy continues on the growth path. But what is the short-term scenario going to be like?
Crude oil prices have been firm over the last three months. Given the volatile geopolitical scenario in the crude oil-producing nations, the prices are unlikely to come down. The under recoveries of oil marketing companies have been rising, forcing them to hike the prices of petrol by Rs 5 per litre. Diesel prices have, however, not been touched, but the market expects diesel prices also to go up in the short term. This would push up inflation.
The RBI may continue with its rate hike spree for some more time. “We expect a 50 basis points increase in key interest rates over the next three to six months, which will keep the short-term interest rates firm,” says Ramanathan K, CIO-single manager investments – ING investment management. Nowadays, good credit-rated financial instruments maturing in 90 days offer an annualized yield in the range of 8.75% to 9.25%.
Liquid and liquid plus funds score over savings bank account in returns, but you have to look at various other aspects of the parking facilities to select the one that suits your needs.
A savings bank account allows you to issue checks, which is not possible with mutual funds. To pay house rent to the landlady, you have to redeem your liquid funds units, let the proceeds come to the savings bank account and then issue a check.
The second issue is about the operational aspects of investing in these funds. You receive money in the savings bank account either as salary or from some other transaction. Hence, the savings bank account is the parking space for your money by default.
But if you want to put some of that amount in mutual funds, you will have to either do it yourself or identify an agent who can do it for you.
Since money in liquid plus funds is parked only for short terms, there would be a right series of transactions taking place frequently. It may be difficult for you to find the time or keep track of such transactions. And no institutional or individual agent operating in an offline setup will help you since this business is not remunerative. The only way out for you is to either approach an online fund distributor such as fundsupermart, investonline.in or make investments from online platforms of large institutional distributors.
But before you transact using online platforms, it would be wise to confirm if there are any charges applicable. You may also choose to open an online account with a fund house and map your mutual fund portfolio on that account. This ensures seamless transfer of funds.
Liquid and liquid plus funds can be further employed to boost your returns on investments. “If you have a large corpus of money to invest in equity, then instead of a systematic investment plan, opt for a systematic transfer plan, which gives you both the benefit of averaging in equity fund and also better returns of a liquid fund vis a vis a savings account,” says Rajesh Krishnamoorthy, managing director, fundsupermart.com, an online mutual fund distribution entity.