With whatever experience I have in Industry, clients always ask me to park funds in Savings Account or Current Account (if the client is an individual client then they will have a savings account, if the client is operating his/her business then they will have a current account). Usually, the client requires funds in the short term (say within 6 months). Even at my home, the wife usually argues with me when I ask her not to park money in Savings Bank Account. At times it amuses me and at the same time question arises. Do investors know what their banks are up to? Do investors know what is the best possible route to generate returns at the same time maintain liquidity? Do investors know what liquid funds are? Do they know enough about the savings bank account?
Let me take you through why savings/current bank account 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 fund 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 loan. Cheapest of them is housing loan which is usually offered around 10% (depends on credit history as well).
Let’s say, there is 1000 savings account 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). Bank lends at suppose 10% so earning would be Rs. 900,000 (9 lakhs). Net earnings of the bank would be Rs. 500,000 (5 lakhs).
Savings account as a product is 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 fund is practically ZERO for banks as banks don’t have to pay anything to account holders for maintaining balance. However 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 the 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 since Liquid Funds invest in the market, and 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 happen 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 lesser 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 arises that in a savings account I am sure that I will get the interest rate specified by the bank which is 4% or 6% depending on with which bank I have the account. But in case of liquid funds there is no surety of return — To that my response would be, there no such surety about the return but once can have sound judgment on what return one will get. One good indicator would be to look at call rates by RBI, which hovers around 7–7.50% so one can expect return around that at least which is more than that of Savings Account and Current Account.
Take an example of 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 saving account which would earn a mere 4% interest. And the best part is that you get returns of Fixed deposits with liquidity and security of a saving account. Do I need to say more?