Considering that the stock markets have been touching record highs for the last few months, a lot of investors recently booked profits and are holding on to the cash rather than re-entering the market at such elevated levels.

While it is always wise to keep some amount of cash aside for emergencies, keeping excess cash in a savings bank account maybe counter-productive as it yields comparatively lower returns. It may make sense from a safety point of view, but the interest earned in this case is so inadequate as to not even match current inflation levels.

In such a scenario, investors would do better toinvest their idle money in liquid mutual funds.

Liquid funds are debt mutual funds that invest in very short-term debt instruments such as government securities, certificates of deposit, treasury bills, and commercial papers. These instruments carry comparatively lowerrisk astheir maturity is up to 91 days. Further, as the name suggests, liquid funds are highly liquid and can be an alternative to bank savings account forshort-term parkingof idle money.

Liquid funds vsSavings Bank Account

Returns: Historically, liquid funds have delivered higher returns than traditional savings accounts. While savings accounts typically offer fixed returns of 3-4% annually, liquid funds have the scope of generating higher returns, particularly in a rising rate environment as securities with short-term maturities get reinvested at a higher interest rate.

Taxation:Interest earned in a savings bank account gets taxed as per the income tax slab rate of the individual.In case of liquid funds, short-term or long-term capital gains tax may apply depending on the investment period. For any investments that last less than three years, returns earned will be taxed as per the income tax slab rate. But in case of long-term investments of three years or more, the returns will be taxed at 20% with indexation benefit. Indexation benefit refers to the adjusting of the principal amount for inflation prior to tax calculation.

Liquidity:Liquid funds are as liquid as bank accounts where money can be redeemed instantaneously. However, exit load is applicable if the money invested is withdrawn within the first seven days of investment. For any withdrawals from the liquid fund after seven days of investment, there is no exit load.

Apart from these features, liquid funds have no lock-in as in the case of fixed deposits, and also offer investment options such as growth and dividend. Therefore, liquid funds can be an attractive alternative to savings bank account if one is looking to park their surplus funds at low risk and seek to gain higher returns than the savings bank account interest.

Liquid funds can also work well for investors who are looking to enter equity mutual funds, but do not want to enter at current levels. Such investors may park their idle money in a liquid fund and opt for a systematic transfer plan (STP) into their chosen equity fund over the next one or two years, making the most of a possible correction in equities.