Company FDs vs Liquid Funds – Which Should You Opt for?
Last Updated : May 30, 2019, 2:54 p.m.
As per the latest reports, Dewan Housing Finance Limited (DHFL) has stopped accepting fresh inflows in fixed deposits from the public. Not only that, the housing finance major has also disallowed renewals and put premature withdrawal from FDs on hold. Withdrawals are permitted only during medical emergencies. Market experts feel the action taken by DHFL could be replicated by other Housing Finance Companies (HFCs) and non-banking finance companies (NBFCs) as well. Fixed deposits offered by these entities come under the category of company FDs, which are different from fixed deposits that are there at banks.
The noteworthy point is that the debt portion of several HFCs and NBFCs has become risky over the past one year. In addition, some of these companies are struggling with weak financials. All this and more raises a question mark over whether one should go with company FD or look for other alternatives such as liquid funds that offer enhanced liquidity to the investors. Let’s check out here the differences between company FD & liquid funds and find out which is a better option.
Differences Between Company FDs & Liquid Funds
The table below weighs company FDs and liquid funds on different aspects.
| Investment Aspects | Company FDs | Liquid Funds |
|---|---|---|
| Returns | Can offer greater returns | Can offer comparatively lower returns |
| Liquidity | Low liquidity | High liquidity |
| Holding Period | Up to 5 Years | As long as you want to hold them |
| Investment Modes | Lump sum | Lump sum and systematic investment plan (SIP) |
| Risk | Riskier as the deposits are not secured against the company assets. The risk prevails on both interest and principal repayments | Risk is on the lower side as the money is invested in instruments having short maturities |
| Taxation | TDS at 10% is deducted if the interest earned exceeds ₹5,000 in a financial year | Capital gain tax at 20% with indexation benefits on redeeming the units after 3 years |
What is a Company Fixed Deposit?
HFCs and NBFCs raise money by issuing fixed deposits to the public. The money helps the company manage its working capital requirements and expand its operation.
What is a Liquid Fund?
Liquid fund is a part of debt mutual funds that invests primarily in money-market instruments having a short-term maturity of up to 91 days. These instruments include treasury bills, certificates of deposit, commercial paper, etc.
Where Should You Invest a Large Corpus – Company FD or Liquid Fund?
Even though company FDs offer scope for greater returns, investing a large corpus in the same can pose serious risks to the investors. The default risks in interest and principal repayment make it a challenging affair for those investing a huge chunk in company FDs. You can thus choose Liquid funds that are relatively safer.
Indexation Benefit Tilts the Game Further in Favour of Liquid Funds
The table above showed the indexation benefits for those redeeming the liquid fund units after 3 years. You must be interested to know what these indexation benefits are all about, right? Well, the indexation takes into account the Cost Inflation Index (CII) to inflate the purchase price.
CII for different financial years is fixed by the government. The inflation-adjusted purchase price is obviously a lot higher than the amount you must have invested to buy the fund units. When the inflation-adjusted purchase cost is deducted from the sale value, the capital gain that arrives is an inflation-adjusted one. This further results in reducing the tax liability.
Formula for Indexed Cost of Acquisition
Indexed Cost = (CII for the year in which the fund units are sold/CII for the year in which the units were purchased) x purchase cost
So you bought 10,000 units of liquid funds worth ₹1,50,000 in March 2012 and sold all the units for a sum of ₹2,50,000 in April 2015. In that case, it will be considered as long-term capital gain as the units were held for more than 3 years. CII for FY 2011-12 and FY 2015-16 are 785 and 1081.
Indexed Cost = (1081/785) x 1,50,000 = ₹2,06,560.51 (approx.)
Long-term capital gains with indexation = Sale Value-Indexed Cost of Acquisition
= ₹2,50,000-₹2,06,560.51
= ₹43,439.49 (approx.)
Long-term capital gain tax with indexation = ₹8,687.90 (approx.) (20% of 43,439.49)
Long-term capital gains without indexation = Sale Value-Cost of Purchase
= ₹2,50,000-1,50,000
= ₹1,00,000
Long-term capital gain tax without indexation = ₹20,000 (20% of 1,00,000)
Conclusion
Company FDs can offer more returns than liquid funds. But given the default risks and less tax efficiency, it would be better to avoid investing in them. Instead, one should look to invest in liquid funds and enjoy the liquidity and indexation benefits that they are known to offer.
However, if you still want to invest in company FDs, make sure to put the money in fixed deposits of those entities having assigned a credit rating of AAA or AA by agencies such as CRISIL, ICRA, CARE, etc. Investing in FDs of companies having such credit rating can make your capital safer but the returns won’t be that high.