Hiren DhakanBonanza Portfolio
The Finance Minister rolled out a tax saving avenue for the masses by giving a tax deduction of Rs. 10,000 for interest earned on savings bank account in the current year’s budget. This coupled with the fact that the interest rates as high as 7% are being offered by certain banks, keeping cash stacked at your bank accounts is now no longer considered to be dumb. These two moves may have saved the day for savings bank accounts when compared with short term deposit rates and liquid funds but if we consider the ‘after tax returns’, the table is turned around.
| Interest after tax (including deduction) | ||||||
| Investment / Tax Slab | 30% | 20% | 10% | |||
| Liquid Fund | Savings A/c | Liquid Fund | Savings A/c | Liquid Fund | Savings A/c | |
| 50,000 | 3,337.33 | 3,068.18 | 3,337.33 | 3,068.18 | 3,337.33 | 3,068.18 |
| 1,50,000 | 10,011.99 | 9,729.31 | 10,011.99 | 9,729.31 | 10,011.99 | 9,729.31 |
| 3,00,000 | 20,023.97 | 17,261.14 | 20,023.97 | 18,343.48 | 20,023.97 | 19,425.82 |
| 3,50,000 | 23,361.30 | 19,743.87 | 23,361.30 | 21,196.28 | 23,361.30 | 22,648.70 |
| 5,00,000 | 33,373.29 | 27,192.06 | 33,373.29 | 29,754.69 | 33,373.29 | 32,317.33 |
| 8,00,000 | 53,397.26 | 42,088.43 | 53,397.26 | 46,871.52 | 53,397.26 | 51,654.60 |
There is an on-going feeling post the budget that the new tax deduction offered to savings accounts would make them superior to liquid funds in terms of returns and liquidity. I beg to defer.
| Assumptions: |
| 1. You are invested the same amount throughout the year. No withdrawals/investments. |
| 2. There are no charges levied throughout the year |
| 3. Interest compounded quarterly |
| 4. Interest in savings bank account 6% upto 1 lac, 7% for balance above 1 lac |
| 5. Liquid fund yield is last 1 year average performance of liquid funds |
A comparison of post-tax yields of liquid funds and savings accounts clearly show that liquid funds still pose tough competition to savings accounts with their superior post-tax returns even after considering the effect of the newly introduced tax deduction of Rs. 10000.
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As it can be seen in the table above, the difference in the ‘after tax returns’ of liquid funds and savings accounts is more when the individual is into the highest tax bracket of 30% and as the amount lying into the accounts gets bigger. Irrespective of what the what the amount is and what tax bracket the investor falls into, liquid funds still beat savings accounts primarily due to two reasons: 1) the average returns of liquid funds over the past 1 year has been close to 9% vis-à-vis 6-7% provided by savings accounts. 2) Dividend Distribution Tax (DDT) on liquid funds is currently at 27.0375% while interest on savings accounts is taxed as per tax slab i.e. 30.9%/20.6%/10.3%.
But before making a choice amongst the two, one needs to consider some crucial aspects regarding these instruments which at times may matter much more to an individual investor:
- The NAV of a Liquid fund changes daily and thus the interest is, in a way, paid out or accrued on a daily basis. In contrast to this, most banks follow ‘Average Quarterly Balance (AQB)’ concept which means that you will be paid out interest at the end of every quarter on the average amount you’ve kept in your account for those 90 odd days. So if your investments are going to be for anything less than 90 days or if you require your interest amount before the quarter ends liquid funds should be your choice without getting much into the details.
-There are no charges in liquid funds if you are not maintaining a particular balance whereas in the case of savings account if you your AQB falls short of the minimum balance you may be charged anywhere between Rs. 100-1000 by your bank.
-If convenience is what you prioritize over extra returns, savings bank accounts should be your choice. As if you are having a hefty balance in savings accounts, you may be offered a premier account with fringe benefits like dedicated relationship manager and other personalized services which you’ll not find in liquid funds.
-Funds in your savings accounts are quite liquid and easily accessible as you can withdraw from any ATM anytime. Liquid funds do take some time in processing redemptions and thus they are not the avenues to keep funds which you might need instantaneously or at emergencies. Undoubtedly there are few liquid funds that have started ATM services for redeeming funds, but the choices are few. Secondly, liquid funds in India unlike those in US do not provide the facility to write cheques on the funds.
The author is Associate Fund Manager of Bonanza Portfolio
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