How to improve returns from the idle cash lying in Saving/Current Account

We should not let our money idle in the savings bank account, it can be invested to earn a better returns without compromising liquidity or taking high risks.

After demonetisation about  Rs ten lakh crore is deposited in the last three weeks, the savings bank accounts of Indians are bulging with cash. As government has put restrictions on withdrawals, a large chunk of this money is going to stay put for the next few months, earning a paltry interest of 4% per year. Though the interest on the savings accounts is tax free up to Rs.10,000 per year,  Still it's not a good idea to keep Rs. 2.5 lakh idling in your bank account. The interest it will earn won't be able to beat inflation, and the purchasing power of money will come down. Of course, this money was losing value faster when it was lying in your locker as hard cash.

We have various options to deploy this idle money to earn higher returns without compromising liquidity or incurring high risks. The choice should depend on how soon the money will be needed and income tax bracket and also the willingness to make a little effort.

1. Bank fixed deposit

The simplest and easiest way to deploy saving/current account bank balance is to open a fixed deposit, though the returns may not be very exciting and Banks have already slashed the interest rates on short-term deposits. A one-year deposit in the State Bank of India will now fetch only 4%, which is equal to what a savings bank account earns. The rates for longer term deposits are little higher, but mind it the interest earned on fixed deposits is fully taxable. If an investor is in the highest tax bracket, the post-tax return could be even less than saving interest rate. Also, unless we have a online/Netbanking account, opening a fixed deposit won't be easy at a time when visiting the bank is like entering a war zone.

The best way out is to open a long-term deposit of 3-5 years and break it when money is required, we can also keep small denominations FD so that it can be used if only a part of the money is needed. Most of the banks no longer levy a penalty for premature withdrawals. But interest rate to be paid will be applicable rate for the period we remained invested, which is usually lower than the longer-term rate. Also, if the interest income exceeds Rs. 10,000 in a year, the bank will deduct TDS.

This is fine if a person’s income is above the basic exemption limit of Rs. 2.5 lakh per year. But investors in the zero tax bracket will have to file their returns to get a refund of the TDS, or submit the Form 15 G or H to escape the TDS.

Now for recurring deposits too, the interest earned is fully taxable. These deposits were not subject to TDS, but the rules have now been amended.

An investor can also consider opening a sweep-in bank account, where any excess amount in savings account automatically flows into a fixed deposit. If we withdraw from savings account, the fixed deposit is automatically broken.

2. Liquid funds and ultra-short-term funds

Mutual fund is another smart way of earning more income without compromising on liquidity. We can invest in liquid mutual funds. These are ultra-safe schemes that can deliver up to 7-8% returns in a year. The biggest benefit is that the income from mutual funds is treated as capital gains and taxed at a lower rate if the investment is held for at least three years.

They are also more flexible. We can withdraw small amounts whenever required or invest more when we have surplus cash. Now various online platforms are available through which we can invest and redeem very easily and instantly.

The risk of losing money in a liquid fund is almost negligible. The investment is also very liquid. If you redeem before the cut-off time (usually 12.30 pm), the money is in your bank account the next morning at the latest. There is no minimum investing period either. Some mutual funds also offers instants redemption by which money can be credited to an investors account within 30 minutes (upto Rs. 2 lakhs) including holidays and Sundays.

3. Short-term debt funds

Those who don't need the money for the next 6-12 months can opt for short-term debt funds. These are also debt schemes, but invest in a mix of short term and medium-term bonds. The returns are slightly higher than what liquid funds and ultra short-term debt funds give, but there is also an exit load payable if we redeem before a minimum period that ranges from 3-12 months. In few schemes, the minimum investment period can be up to 36 months. Before investing we should check the exit load of the income fund or where a penalty of 0.5-1 % can pare the returns.

In the current scenario as interest rates are expected to decline, these funds can give attractive returns in the short to medium terms. Even in the long term, they will give better post-tax returns than fixed deposits. However, these funds also carry an interest rate risk. Of late these schemes have delivered good returns because interest rates have been consistently declining. If interest rates rise, these funds can decline, resulting in losses.

4. Arbitrage funds

Arbitrage funds are for those Investors who can hold for one year or more as they offer tax-free returns. These funds invest in stocks and equity instruments but don't carry market risk. The gains are taxed at 15% if redeemed within one year however dividend received is tax free. After one year, the capital gains are  also tax free. Before investments we should also check the exit load of the arbitrage fund, otherwise the penalty of 0.5-1% can pare the returns.

5. Monthly income plans

If an investor can bear certain degree of risk, monthly income plans (MIPs) from mutual funds can be a low-risk entry point to the equity markets. MIP schemes follow a conservative investment strategy, allocating only 10-25% of their corpus to equities and putting the rest in safer bonds and instruments. Their returns are better than debt funds, though they also carry a moderate risk. These funds have exit loads so check the terms and conditions.

Bank deposits were traditionally the only and safer option for the investors to keep money and withdraw as per convenience however now when the bank FD rates are historically low and there is lot of awareness regarding mutual funds, we should look at various type of mutual funds which can give safety as well as better returns compare to traditional products.