A fundamental part of prudent financial planning is to keep enough “ready” cash in hand to meet any unexpected emergencies. That doesn’t mean stashing the cash under the mattress or letting your money shrink itself in the regular savings bank account. Money lying in idle is money lost as inflation keeps chipping away at its worth. However, one cannot fully invest the entire of the money in search for higher returns, as it also means one is also risking the capital.
This brings us down to few investment opportunities where one can park their money.
Savings Bank Account: Whether or not the best, it is often the most favored by investors who perceive all other instruments as risky. Money which remains in the bank post expenses and investments is mostly the part of SB account. This provides the maximum liquidity being accessible from anywhere with the help of debit cards or cheques. However, when it comes to growth, it is quite minimal. There are two fundamental changes directed by RBI, one being Banks being given the right to decide on the rate of interest on SB account depending on various internal parameters and second, the way the interest is calculated on savings.
Earlier, all banks offered same rate of interest, thus there was very little to choose from in terms of which bank to open an account with. Now, with banks choosing their rate of interests on SB account, investors can choose depending on:
► If one hardly keeps any cash in bank and transact regularly, then the best bank is which has higher number of ATM’s as the transactions from other bank ATM’s are charged.
►If one has huge amounts lying in the bank, it is advisable to choose the bank which offers higher rate of interest on SB account.
There has also been a change in the way the interest is calculated on the SB account. Earlier it was based on the lowest end-of-day balance from the 10th day of the month to the last day of the month. Now, it has been changed to interest calculated on daily basis based on the day end balance in the account, which results in higher interest amount.
Some banks are offering up to 7% annual interest on the SB accounts, which is fairly high compared to average going rate of 4%. If you have a sizable amount of money in your savings account, you can consider switching over to banks which offer higher rates.
Taxation on Interest on Savings Account: Interest earned up to Rs 10,000 in Savings account in one financial year is exempted from tax under section 80TTA. Beyond this, the interest amount will be added under the head of income from other sources and taxable as per the tax slab of the investor.
With inflation eating away the principal amount, even the savings emergency funds have to be planned wisely in order to minimise the effect of inflation.
The value of Rs 100 in the bank growing at 4% would have diminished when inflation is factored. The Rs 100, after interest accruals would have appreciated grown to Rs 122 in five years, but adjusted for 8% inflation, your corpus would effectively be worth Rs 82.80.
Even at 6% interest, the value of the savings seem to have lost, but then this is an emergency fund so one cannot put it in a risky asset or in a product where liquidity is not there. The entire essence of maintaining emergency fund is to ensure that the money saved is accessible in emergency.
While this Emergency fund is essential, it is also important that the emergency fund grows to at least be closer to the value after inflation is factored.
One such product which can help with decent liquidity and better returns is liquid mutual fund. These funds are usually preferred by corporate entities to make their cash reserves more productive. Generally, the money which is lying in the corporate account, and is required after few days is parked in liquid funds.
Liquid Funds are those funds where the investment is made in money market instruments with residual maturity not than 91 days. Liquid funds, as the name suggests, offer almost instant liquidity. They can be redeemed in T+1 day, i.e. the next business day after the transaction. As the average maturity is low they have lower interest rate risk. These funds also do not have any entry or exit loads generally.
Liquid funds have dividend payout, dividend reinvestment and growth options. Depending on the requirement, any of the options can be chosen.
In case one is looking at some periodic income, the dividend payout option can be chosen. Several funds also offer the daily, monthly or quarterly dividend options. Dividend distribution tax at the rate of 28.3% is deducted and paid to the investor; however it is tax free in the hands of the investor.
In case of redeeming units within 1 year from the date of investment, the capital gains are taxed as per the tax slab of the investor, thus in case you are looking to stay put in the fund for more than a year, the growth option makes sense as in this case the indexation benefit can be availed.
In case of redeeming within one year, investor may opt for dividend reinvestment as the dividend is reinvested at lower NAV (post dividend NAV) and as reinvested amount is considered a fresh investment and as NAV comes down, the capital gains are very low and can be beneficial for investors.
Average returns in case of Liquid funds for the last one year has been in the range of 9.2-9.3%. The things which one has to keep in mind while investing in liquid funds are
► Fund’s average maturity (lesser the volatility, lower the interest rate risk),
►Expense Ratio (lower the better)
►Consistency in the returns or instead of huge peaks and troughs
The SIP Catch
As the average returns are decent, an SIP in liquid funds will help in creating a compounding effect and may work in favor of an investor. One can plan a part of the emergency saving to be put in liquid fund as an SIP. However, one has to understand that each of SIP installments is considered a fresh investment and will have to complete one year for indexation benefit. Average returns of on- year SIP was around 9.23% as on 18 March, 2014.