With interest rates as low as 2.5% at major banks like State Bank of India, and considering inflation and taxes, your savings might be shrinking. This is because, with lower interest rates, your saving account might be like a leaky bucket.
Keeping large sums in a traditional savings account can be detrimental and there are several alternative investment options that are available to park your money in.
Take an example of keeping Rs 1 lakh in a savings account, after accounting for 30% tax and 4% inflation, the effective value after one year drops to Rs 97,750, resulting in a loss. Here are four smarter alternatives.
Flexi Fixed Deposits Or Sweep-In Facility
These automatically convert excess funds in your savings account into fixed deposits, offering higher interest rates. However, the interest is taxable at the slab rate, and the fixed deposit value decreases with transactions.
Short-Term Debt Funds
These mutual funds options of liquid, overnight, ultra-short duration funds, invest in money market instruments, providing better returns than savings accounts.
Tax is deferred until withdrawal and the downside is liquidity. This means that funds will not be readily accessible like a savings account. These funds typically become available the day after redemption.
Arbitrage Funds
These capitalise on price discrepancies between cash and derivatives markets in equity. They offer higher returns than liquid funds and benefit from equity taxation.
This options carries a slightly higher risk and require a minimum six-month holding period. Like short-term debt funds, they are liquid but not as easily accessible as a savings account.
Income Plus Arbitrage Funds
A newer hybrid option combining features of liquid and arbitrage funds. This provides better interest rates and long-term capital gains tax benefits which is 12.5% after two years.
Further, the liquidity remains a concern. Investors need to know that the fund-of-fund structure might incur higher costs.
In conclusion, while these alternatives offer better returns, none match the immediate liquidity of a savings account or cash.
Investors can keep enough funds in a savings account for emergencies and invest the rest in these alternatives. Parking funds in an arbitrage or liquid funds can earn more than the typical 2.5% savings rate.
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