Liquid funds with instant redemption facility offer investors a clear advantage over bank FDs.

Interest rates on bank fixed deposits are likely to fall further because of the surplus liquid ity that's been pumped into the system after the demonetisation exercise. Liquid and ultra short-term funds have emerged as a more viable alternative for parking the excess cash lying in bank savings accounts. These funds offer a much higher yield for investors.

However, while bank fixed deposits (FD) offer instant liquidity to investors, liquid funds, until recently, took at least one business day to return investors' money.This has changed recently, with two prominent fund houses--Reliance Mutual Fund and DSP BlackRock Mutual Fund--offering instant redemption facility on their liquid funds.

Both these ultra-short term schemes, allow investors to withdraw their money any time by placing a redemption request and the money is credited to the investor's bank account instantaneously. Investors can redeem up to 95% of the amount in their account, subject to a maximum of `2 lakh per day. The minimum withdrawal amount is `500 for Reliance Money Manager and `100 for DSP BlackRock Money Manager Fund. While other fund houses are expected to follow suit, the market watchdog, Securities and Exchange Board of India (Sebi), is reportedly exploring the option of making instant withdrawals, subject to certain caps, mandatory for liquid funds.

Reliance mutual fund also offers Any Time Money Card--an ATM cum debit card--which offers easy accessibility to money parked in its liquid schemes through Visa-enabled ATMs. Investors can withdraw upto 50% of their corpus in the scheme, or `50,000 per day, whichever is less. It also doubles up as a debit card, where investors can spend upto 50% of the corpus or `1 lakh, per day. This facility has been extended to investors of Reliance Liquid Fund--treasury and cash plans--and Reliance Money Manager Fund.

The added benefit of easy liquidity makes liquid funds a better alternative to both savings bank account and bank FDs. "With instant redemption facility, liquid funds now carry a distinct advantage over the traditional savings avenues.They are particularly useful for those with a large balance in their savings accounts, which is highly tax inefficient for interest income in excess of `10,000. Even a sweep-in fixed deposit facility--where funds can be transferred between savings bank and fixed deposits--would yield sub-optimal returns compared to Investing money in a liquid fund.

Liquid funds are essentially very low-risk funds, investing in highly liquid money market instruments with a residual maturity of not more than 91 days. As such, the volatility in these instruments is very low. Liquid funds have delivered around 7.6% over the past one year.Since these are debt funds, gains are taxed in accordance with one's income tax slab, if held for less than three years. Assuming a 7.5% return on liquid funds, after-tax returns work out to be 6.8%, 6% and 5.3% respectively for individuals in the 10, 20 and 30% tax bracket. This currently works out higher than the after-tax return from bank fixed deposits.