Suresh Sadagopan Ladder7 Financial Advisories
Liquidity is an important facet of one’s personal finances. Sudden surges in expenses, disruption in cash flows, unexpected outflows can all happen in one’s life. In such situations, liquidity margin kept aside come in really handy.
Most people keep aside money in their savings account for liquidity. Savings accounts normally earn about 4% pa. ( though some banks are offering upto 6% pa on the savings account balances ). These interests are taxable above Rs.10,000/-pa. I have seen my clients maintaining several lakhs of rupees in their savings account as they want to keep a good cushion handy always. Some maintain the same in short-term fixed deposits, which are better than Savings account return, but has a tenure. But, are savings accounts & fixed deposits the best way to maintain liquidity? Are there better ways of managing liquidity?
There are indeed better ways to manage liquidity, which we will discuss here.
Short duration debt funds: Mutual funds have both debt and equity oriented funds. Among debt schemes, there are those which invest in papers of very short duration. We have a category called liquid funds which predominantly invests in very short term instruments between one day and 30 days. The returns from these funds have been 1-1.5% above the savings bank rate, in the past. Currently however, even liquid funds are giving 8-9% pa returns. This is significantly better than the prevailing savings bank interest rates.
Most of these liquid funds also do not have any exit loads. This means one could invest on any day and exit on any other day, without any penalties. This gives the investor tremendous flexibility in managing their money optimally and keeping their liquidity intact, at the same time earning good returns.
There are other schemes which belong to the ultra short-term category of funds, where the instruments in which it invests are of higher durations as compared to the liquid funds. Here the duration can be between 2-3 months to a year. Normally, the instruments into which ultra short-term funds invest would yield more, in view of their somewhat higher duration.
Currently, Ultra short-term funds are offering in the region of 9-9.5% pa, which is much higher than the long-term average returns for this category. When the interest rates wind down, the returns offered by various categories of debt funds including Ultra short-term funds will also come down.
This category may have exit loads for a certain number of days – usually between 7-30 days. There are some funds where there are no exit loads too.
Tax treatment: In case of debt funds, one can invest in growth or dividend option. If invested in the growth option, the tax treatment would be as per the tax slabs for less than 12 month investment and Longterm capital gain treatment for over 12 months. For debt funds, longterm capital gains tax is the lower of 10% without indexation or 20% with indexation. Indexation is just adjustment of your principal for inflation. With indexation, the effective tax would be just 5-7%. Hence, it will be a good idea to invest one’s liquidity margin in growth option, if the chances of it’s short-term usage are low.
If the money would be required within 12 months of deployment, then Dividend mode would be a marginally better option for those in the highest tax slab. The dividend distribution tax ( DDT ) is 28.325%. This is better than the 30.9%, a person in highest tax slab would pay. For those in the lower tax brackets, growth option itself would be better.
For liquidity, these funds would be suitable options. There are contingency funds also which are kept aside to take care of funding requirements for medical emergencies, sudden cash requirements for near and dear ones etc., for which again debt funds can be used. But for these, comparatively longer term funds can be used. One could use medium term funds, dynamically managed funds, short term funds, income funds and ultra short-term funds for contingency funding purposes as the chances of these funds remaining invested for a longtime.
This way one can manage the liquidity/ contingency funding requirements and also earn a decent return on the amounts deployed towards these.
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