With whatever expertise I have in Business, customers always ask me to park funds from Savings Account or Current Account (in case the customer is a single customer then they’ll have a savings account, in the event the customer is working his/her company then they’ll have a current account). Normally, the customer requires funds in the brief term (say in 6 weeks ). At my house-wife and I usually argue once I ask her not to park cash. Occasionally I am amused by it and at precisely the exact same time query arises. Do investors understand exactly what their banks are up to? Do investors understand the path to create returns in precisely the exact same time? Do investors understand what resources that are liquid are? Do they understand enough?
Let me take you through why savings/current bank accounts as a product is marketed and why liquid funds as a product are not enough marketed.
For most of the institutions say Bank, savings account acts as a source of money rather than a source of income. When someone parks funds in a savings bank account, banks normally offer 4% or more than 4% (RBI guideline says that minimum deposit rate should be 4% but banks can offer to pay more), the same fund banks can lend at more than 4% to earn income. Lending for banks includes Housing loan, Personal loan and Commercial loans. Cheapest of them is a housing loan which is usually offered around 10% (depends on credit history as well).
Let’s say, there are 1000 savings accounts and each one has a balance of Rs. 10,000 so banks have to shell 4% of Rs. 10,000,000 (1 crore) which is Rs. 400,000 (4 lakhs) as an interest payment to account holders. In turn, banks lend Rs. 90,00,000 (90 lakhs) (since bank can’t lend all which is present in the savings account as a part of the regulatory framework). The bank lends at suppose 10% so earning would be Rs. 900,000 (9 lakhs). The bank’s net earnings of the bank would be Rs. 500,000 (5 lakhs).
Savings accounts as a product are advertised more because banks get funds at a lesser cost and hence banks can earn more. The current account is another example where the cost of funds is practically ZERO for banks as banks don’t have to pay anything to account holders for maintaining balance. However, the current account is not marketed since it is not meant for the mass public. Fixed deposits also act as a source of the fund but banks pay the higher cost for that around 8–9%. Hence there’s less marketing around that.
Where in Liquid Funds is a kind of mutual fund where the money is invested in debt instruments like commercial papers, sovereign bonds, treasury bills, fixed deposits whose maturity is less than a month? The exit load (penalty for exiting early) over here is zero compared to other mutual funds where it is normally in the range of 0.5% to 2% for 365 days. The expense ratio (charged from an investor) is minimal for liquid funds which are in the range of around 0.05% to 0.10% (10 paise per 100 Rs.). For other mutual funds, it is normally around 2.35% to 2.5%. So the question of liquidity doesn’t come here like savings account or FD which is highly liquid as well as one can invest in liquid funds for a day as well (no restriction on minimum day criteria, it is like a zero balance account).
One might argue that since Liquid Funds invest in the market, it is risky compared to savings account funds. The above argument holds true when liquid funds invest in longer duration bonds where the price fluctuation happens with interest rates. Liquid funds primarily invest in products like commercial papers, treasury bills, money market instruments whose maturity is largely around 91 days even less than that. Also, investment will be an instrument whose credit rating is highest like AAA/P1+ or it is invested in government bills issued by RBI (probability of government defaulting is very low). And within 91 days’ chances are almost impossible that AAA-rated company will go bankrupt where the company is not able to pay the money.
The question also appears that in a savings account I am sure I will find the rate of interest specified depending on. However, in the case of funds, there’s no surety of recurrence — to this, my answer is there’s no such surety regarding how the yield can have a sound judgment on what return one can get. 1 good indicator would be to look at call rates by RBI, which hovers about 7–7.50% so one can anticipate return around that which is over that of Savings Account and Current Account.
Take an example of the HDFC Liquid Fund — the example composition of the mentioned fund is below.
I am a strong believer in generating maximum returns with minimum possible risk. If you have idle funds, why not put them to work in a liquid fund and earn higher returns rather than leaving them in a savings account which would earn a mere 4% interest. The best part is that you get returns on Fixed deposits with liquidity and security of a savings account. Do I need to say more?