You needn't park so much in that SB a/c

[Sukumar]

Have you ever given a thought to the amount lying in your savings bank
account? Are you satisfied with the 3.5 per cent interest that you
earn on it? Or do you feel it is a price you have to pay for
liquidity?

Well, it's not like you don't have a choice. A liquid fund, for
example, could serve much the same purpose while yielding much better
returns.

A liquid fund is a mutual fund that invests only in money market and
short-term debt instruments whose tenure is generally less than a
year. Its portfolio comprises instruments such as commercial papers,
treasury bills, certificates of deposits and repos, etc.

These funds aim at preserving the capital and yielding a conservative
return by investing in shorter-term maturity papers since they are
less impacted by the interest rate movements.

As on January 31, 2008, the total amount of assets under management by
liquid funds was in excess of Rs 4.2 lakh crore.

Advantages of liquid funds

Unaffected by uncertainity

Liquid funds are an uncertain investor's biggest ally. Whether the
investor is uncertain with regard to the interest rate scenario or
uncertain about what he wants to do with his money is immaterial.
Liquid funds address both these uncertainties. They are ideal for
investors who have a very short investment timeframe, as short as a
day. So you can invest your money in a liquid fund till such time the
uncertainty is dispelled.

Overcoming interest rate risk

Despite the rising interest rate regime, funds in a savings bank
account yield a return of just 3.5 per cent p.a.

In comparison, as of February 28, 2008, liquid funds have given
returns of around 8 per cent over the last one year.

Variable income

Unlike a savings bank account, the returns offered by liquid funds
vary on two counts. The first is due to the change in interest rates
and the second is on account of trading carried on by the fund manager
in debt markets and inter-bank call money markets.

Debt fund managers attempt to earn an 'extra bit' by trading in debt
paper in these markets. This possibility is absent in case of the
savings bank account.

Tax implications

Irrespective of the time for which your funds lie in the savings bank
account, the interest income earned attracts tax at the personal
income tax rate applicable to you. This means, if you fall in the
highest tax bracket, the rate will be 30 per cent + 10 per cent
surcharge + 2 per cent education cess).When you take this into
consideration, you are left with a mere 2.32 per cent return.

Liquid mutual funds have given an average return of around 8 per cent
in the last one year. If an investor chooses the growth option and
sells out within one year, the capital gain would be added to the
income for the year and taxed depending on the tax bracket he falls
into. Even at the top tax bracket of 33.99 per cent, the returns on
liquid funds are much better than those on the savings bank account.

Also, the investor has the option of choosing the dividend option as
well. Notably, the dividend earned on mutual funds is tax-free in the
hands of the investor, except for the dividend distribution tax of
28.325 per cent (inclusive of surcharge and education cess).

Moreover, if you redeem your investments after one year, the gains are
termed as long term capital gains and the tax rate applicable is just
10 per cent without indexation and 20 per cent with indexation.

Drawbacks of a liquid fund

In case you wish to redeem your holding, the funds are either credited
to your account or a cheque is given to you within 24 hours of lodging
the redemption request. In comparison, with the banking industry
becoming more and more technology driven, funds lying in your savings
bank account are accessible any time of the day.

A few mutual fund houses have fought this limitation as well. They
have started issuing ATM cards to their liquid fund investors, which
permit them to withdraw up to a certain percentage of the balance in
their liquid fund investments any time.

Conclusion

Make your money work for you every single day. Do not lose the
additional bit of interest that you can earn by leaving significant
amounts in your savings bank account. Invest in a liquid fund
instead.

N.Sukumar
Research Analyst