Making the best of cash surpluses

Take your pick from liquid funds, short-term debt funds and fixed deposits.

The area of cash management is often neglected by many investors. They may perceive it to be a mundane subject in comparison to its more glamourous cousin""investments. However, a working knowledge of the basics and application will come in handy.

"Cash management" essentially refers to management of cash surpluses. Today, most of us are earning a lot more compared with what we were earning a few years back.

While our expenses may have also increased, many of us are facing a situation, whereby, increasingly large sums are lying idle in our savings bank accounts. These amounts earn very low interest rates (around 3.5 per cent), which do not even beat inflation.

To top that, the Section 80L tax shelter has also been withdrawn. Hence even these paltry returns cannot now escape the taxman's net. So what are the options available?

At the outset, I must say that none of the below mentioned schemes are exempt from taxation. The only difference is that in some of them, taxation is at the fund level.

Liquid Funds: Most mutual funds offer these schemes. They invest primarily in instruments with a maturity of less than a year and, hence, have the least interest rate risk.

This means that they will exhibit the least negative reaction in the event of rising rates, thereby, imparting a high degree of protection to the capital.

Year-on-year returns generated by liquid funds have ranged between 4.58-7.12 per cent with expense ratios between 0.16-1.05 per cent. Considering that debt funds earn lower returns as compared to those given by equity funds, the investor should choose funds that have low expenses.

While this may mean that you will have to choose your funds carefully, it also shows that as an asset class, liquid funds beat the returns given by a savings bank account.

These funds also offer the growth and dividend options. The growth option is more suitable for investors in the lower tax bracket (10 per cent), while the dividend option is suited to investors in the 20 per cent and 30 per cent brackets.

This is because, in the case of dividend schemes, TDS is deducted at the rate of 14.025 per cent and no capital gains liability is attracted. In the case of the growth schemes, the taxation rate will depend upon the income tax slab the investor is in.

The only limitation with liquid funds is that the minimum investment is Rs 1 lakh in the case of most funds. However, as there is no entry or exit load, an investor can invest and redeem the monies at his free will.

Short-term debt funds : Most funds offer these schemes too. They invest in instruments with slightly longer maturities (say between one and three years). While there is a slight chance of capital loss over very short periods, it is not a very material risk.

Most of the other features (such as growth and dividend options and the taxation provisions) are the same as those in liquid funds. However, the plus point for these funds is a very low entry threshold, usually Rs 5,000.

There is also no entry or exit load. These funds have returned between 5.14-7.13 per cent over the past year with expense ratios ranging from 0.65 per cent to 1.10 per cent.

Floating rate funds : These have gained popularity over the past year, as we are witnessing a rising interest rate scenario. They invest in instruments whose yield is linked to a certain benchmark (such as the T-Bill rate or the prime lending rate). As these benchmark rates move up, the interest earned by these investments also rises.

Many frontline mutual funds offer such schemes. The y-o-y returns have ranged between 5.48-6.83 per cent with expense ratios of 0.13-1.25 per cent.

While the entry load is zero in most cases, funds charge a small exit load (0.25-0.50 per cent) in case the money is redeemed before six months. This reduces their attractiveness as short term parking vehicles.

Bank fixed deposits: These have been a traditional favourite. They had lost their lustre for the past few years owing to mutual funds offering better returns, but have now come back with a bang. Today, several banks are offering rates of 8 per cent a year on deposits maturing in nine months.

However, you will have to choose between liquidity and higher returns, as premature withdrawals may reduce returns by as much as 150 basis points.

The writer is vice-president, Parag Parikh Financial Advisory Services