It’s time to ask: is your bank balance truly working for you?
In this article, we explore smarter, safer, and more rewarding alternatives to traditional savings accounts—without compromising on liquidity or peace of mind.
Switching banks
Harshad Chetanwala, co-founder of MyWealthGrowth.com, emphasises that the primary considerations for alternative investments should be safety and liquidity.
There are banks outside the realm of large public and private ones that offer higher savings interest rates. For example, IDFC First Bank offers a 7.25% rate on balances above ₹10 lakh.
However, be aware that this has a graded structure. Balances below ₹5 lakh earn just 3% and those from ₹5-10 lakh earn 5%. So, even someone with a balance of ₹10 lakh will essentially earn a weighted average rate of 4%.
It is possible to find other banks with higher rates, but this involves both the hassle of opening a new bank account and the risk of the bank failing. Money up to ₹5 lakh per customer is insured under Deposit Insurance and Credit Guarantee Corporation rules.
Also read: Bank account for a minor: The best way to optimize your children’s savings
Traditional fixed deposits
Fixed deposits (FDs) offer a tempting alternative to low savings account rates, with yields as high as 8%.
However, this higher return comes at a cost: your money is locked away, and breaking the deposit early triggers a 1% penalty. Moreover, these rates may fall with potential future RBI rate cuts.
“If you break a one-year FD early, you’ll likely receive lower returns compared to liquid funds,” Amit Sahita, director of Fincode Advisory Services explains.
For those considering fixed deposits, Sahita warns against the traditional approach. “If you book a one-year FD at 6.5% and break it on the 40th day, you’ll likely receive an interest rate around 3.5% less; 1% penalty,” he explains. This makes FDs less attractive compared to more flexible alternatives.
Sweep-in FDs
These are FDs without penalties for premature withdrawal. But there is another catch. Any money that is withdrawn prematurely only earns the interest rate applicable to the period for which it was in the FD.
Here’s an example. Assume that a bank has a 7% rate for a one-year FD and 6% rate for a six-month FD. Now assume that you make a sweep-in FD for one year but take the money out after six months. You will only get the six-month rate, which is 6% in this example.
Also read: Are instant-redemption liquid funds better than savings accounts or sweep-in FDs?
Liquid funds
Liquid funds present a more rewarding, liquid alternative to bank accounts, aiming for 5-6% returns via short-term debt.
The tax benefits of liquid funds are two-fold. First, every withdrawal is treated as part capital and part return, so the full withdrawal is not taxed. You can also offset losses from liquid funds against other investment gains and carry those losses forward for eight years. Selling your liquid fund gets you the money in a day, but there’s a small fee if you withdraw within the first week.
“Liquid funds give substantially more than savings accounts, typically trending around 5.5% to 6%,” said Sahita.
He said these funds were ideal for those with immediate financial needs, noting, “If someone has an immediate requirement, they can keep certain amounts in savings, certain amounts in overnight funds, and certain amounts in liquid funds.”
Sahita recommended that for liquid funds, investors should prioritise schemes from reputable fund houses such as SBI, HDFC, and ICICI. They should focus on funds with substantial assets under management (AUM) and a strong pedigree, ensuring a balance between returns, liquidity, and minimal risk.
For those prioritising security and easy access to funds, liquid funds and ultra-short-term funds are the most promising alternatives to a savings account. “If the purpose of keeping money in a bank account is safety and liquidity, then liquid funds or ultra-short-term funds are the best options,” Chetanwala said.
Taxation also plays a crucial role in choosing the right investment. For senior citizens or individuals with an annual income around ₹12 lakh, gains from liquid funds can potentially be tax-free in case of no other income.
Arbitrage funds
These funds exploit the arbitrage between cash and futures in the stock market to generate returns.
These normally mirror returns from liquid funds (currently 5-6%) but are more tax-efficient. That’s because arbitrage funds are taxed as equity funds (20% if redeemed within a year of purchase, and 12.5% thereafter).
However, arbitrage funds come with their own challenges. “Arbitrage funds have volatility issues,” Sahita cautioned. “You can’t just enter and exit whenever you want, and returns are not as predictable as those of liquid funds.”
“For those in the highest tax brackets, arbitrage funds could be an intelligent choice. These funds provide tax efficiency similar to equity investments, while offering relatively stable returns,” Chetanwala said.
Other hybrid funds
Some hybrid funds combine debt and arbitrage in such a way that they are taxed at 12.5% after two years. They can be structured as fund of funds (FoFs) or as dynamic asset allocation funds (DAAFs).
The tax rules dictate that such funds will be taxed at 12.5% after two years provided they hold less than 65% pure debt. These funds can beat arbitrage funds over a two years or more, since longer-dated debt tends to beat arbitrage yields.
However these funds are taxed at the holder’s slab rate in the short term, compared to 20% for arbitrage funds.
Another interesting category here is equity savings funds, which have one third in equity, debt, and arbitrage each and are taxed like equities. However, the risk is higher here due to the equity allocation.
Chetanwala strongly cautioned against hybrid funds, saying they couldn’t replace savings accounts due to their lack of immediate liquidity and safety. “I will not suggest parking money in hybrid funds, even conservative hybrid funds,” he warned. He emphasised that hybrid funds were not suitable for money that’s needed for regular expenses or even within three to four months.
Ultimately, the right alternative to a savings account depends on your individual financial goals, tax situation, and immediate cash flow needs. Consulting a financial advisor can help you navigate these options and make an informed decision.
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