It is an excellent feeling to have a lot of cash stuffed into one’s bank account and sitting on a comfortable sofa relishing the bank balances in your current or saving account. But have you thought how much nicer it would feel if such idle balances would provide you with some more income along with the flexibility of easy accessibility of funds ?
Bank Fixed Deposits – Not A Good Solution
Putting it simply, one of the most common form of investment option known to mankind is bank fixed deposit. You go to the bank and give them your funds for a fixed duration and in return the bank would provide you an interest income for parting with your funds. This is a safe form of investment income and the returns are pretty much known at the time of making a fixed deposit with a bank. However, on a flip side you can not touch your funds till the maturity of the fixed deposit. If you do, the bank would deduct penalty charges before providing your funds back. Let me explain you the implications and how the banks calculate the charges. If you book a FD for 5 years at say 9.5% p.a. interest and you need your funds back due to some emergency within 6 months of the date you booked your FD, the bank before refunding you the FD money would perform a calculation. It shall look into its Interest schedule and find out how much interest would the bank pay if the FD was for initially booked for 6 months. Lets say FD rates for 6 months are 6%. From this 6%, the bank shall deduct a penalty charge of 1% (example). So the bank shall pay back the principal amount of FD with just 5% interest rate. What a loss!!
Hence from the above example, you would easily notice that you can not go ahead investing in FDs if you are not sure that you can invest in the complete maturity period of the FD. Alternatively, if you would go for a shorter maturity period of the FD, say 15 days, 30 days, 45 or 60 days, the interest rates offered by banks are very low. Generally they are less than 5% for this shorter duration. In other cases, banks would not let you invest in FDs if you can not invest for a minimum period of 14 days. In such cases you might think it is better to let the money be in your bank account then to go with the hassles of FDs and bearing the early termination charges.
Money Market Mutual Funds
It is here where you can kick your money lying idle in your bank account and ask it to earn some extra moolah for you. It is all done via investing into Money Market mutual funds (MMFs). Before investing into these MMFs, let me explain you the concept of Money Market.
Generally banks and big corporates require short term liquidity or funding (simply loans) ranging from a couple of hours to several days. To satisfy their liquidity crunch they borrow from banks or other corporates and return back the funds with interest. Interest paid on these short term loans is generally close to prevailing interest rates in the economy. At the time of writing this blog note, the interest is around 8.5% to 9.5%. Hence Money Market means providing short term loans, generally less than 15 days period and mostly on an overnight basis.
Benefits of investing in MMFs
- Investment in MMF is an excellent investment tool for those who want to park their funds for a short duration or are not sure if they can invest their funds for longer duration.
- Irrespective of the duration you invest in MMF, they provide you a stable return close to the interest rate prevailing in the economy. Currently they are providing around 8.5% to 9.5% return which is close to around 1-3 years fixed deposit rates offered by the banks. Even if you withdraw your funds within 1st week of your investment, you shall get the returns at this rate proportionate to your holding period.
- From Tax perspective, MMFs can be used to reduce your tax liability. Interest from Bank fixed deposits are classified under Income from Other sources for tax purposes and is subject to the tax rate of your highest tax slab. MMFs can help you to pay less taxes to the tax man by providing you the dividend option.
- Generally all MMFs credit the funds in your bank account within 1-2 working day from the date you place your redemption request.