What Is the Best Alternative to Savings Accounts?
A savings account may seem like the easiest way to park your money and gain a fixed return. However, they offer very low-interest rates; hence, the return you receive is very nominal.
So, in case you are looking for a safe alternative to a savings account in India, there are a few other investment options, like liquid funds, short-term funds, etc., that can offer you a better return.
Keep reading to find out the best alternative to a savings account.
What Is a Savings Account?
Savings accounts help to enhance your savings by offering interest at the rate of 3% to 6%. These accounts also impose transaction limits on individuals helping them to save a greater amount. Thus, it benefits people with short-term goals to save a sufficient amount of money.
Benefits of a Savings Account
Most people opt for a savings account because of its high liquidity and safety.
The following are the reasons why savings accounts are more widely used:
- You can withdraw money easily through ATM transactions.
- It offers easy money transactions through debit cards, internet banking, cheque payments or online UPI payments.
- Some banks offer higher interest rates to maintain a higher balance in the account. This can provide a slightly higher return without compromising liquidity.
Why Should You Opt for an Alternative to a Savings Account?
Despite its benefits, savings accounts may not be the way to go if you are looking to invest your money for higher returns.
Nowadays, other investment options like fixed deposits, liquid funds, and payments banks offer similar advantages with higher returns.
Here is a list of 6 investment options along with pros and cons that serve as an alternative to a savings account:
- Liquid Funds
If you are a low-risk investor, you can choose to invest in liquid funds for a short term. It works similarly to a bank deposit, where your invested money is invested in fixed-income instruments such as treasury bills, commercial papers, government securities, etc., with a residual maturity period of up to 91 days.
- Good returns: Compared to savings accounts that pay an average interest rate between 3% to 6%, liquid funds can have similar returns with 4% to 6.60% interest rates.
- High liquidity: Liquid funds only take T+1 day to get converted into cash, “T” being the date of transaction.
- Low risk: Compared to other debt funds, the risk of interest rate fluctuation in liquid funds is lower as they mature mostly within 91 days, therefore, do not get severely affected by factors like inflation.
- No lock-in period: Liquid funds do not have a lock-in period. This allows you to withdraw the money at any given time. It can be the best alternative for senior citizens who generally invest in senior citizen savings schemes or post office savings schemes without this flexibility.
- Market risks: liquid funds do not escape the market risks. If the market takes a swing in the negative direction, then your rate of return will be affected. The impact will not be severe, but the returns are not assured.
- Tax: This option does not provide any tax benefits. The return you gain on short-term capital gains gets added to your taxable income.
- Ultra Short-Term Funds
Another alternative to a savings account is an Ultra Short-Term Fund (USTF). These are much similar to liquid funds with a maturity period between 3 months to 6 months. The risk of return for USTF is slightly higher than liquid funds but lower than short-term bonds.
- Higher interest rates: USTF offers considerably higher interest than savings accounts, up to approximately 4% in the short term to 8% in the medium term
- Liquidity: You can redeem the money and get it transferred to your account within 1 business day. So, it offers higher liquidity.
- Low-interest rate risk: The changes in interest rates of ultra-short-term funds are much lower compared to long-term funds.
- Market risks: An USTF possesses greater market risks than liquid funds due to a longer maturity period.
- Defaulter risk: It possesses risks of defaults of both principal amount and interests. Though the possibility of this event is very low, it can not be overlooked.
- Payment Banks
In contrast to traditional banks, RBI introduced a payments bank in 2015 that uses an online wallet instead of a traditional bank account. You can open a savings account in any payment bank. Payment banks are maintained digitally and give you easy access to your money and transaction facilities. Moreover, being a zero-balance account, it serves as a safe alternative to savings accounts.
- Higher interest rates: A payment bank savings account offers a range of 5%-7% interest rate unlike the interest rate of regular savings accounts in most leading Indian banks. Therefore, payment banks are a great alternative to a savings account.
- Minimum account maintenance: You can have a zero-balance account by default. Moreover, unlike a savings account, it saves you from the maintenance penalty.
- Easy transaction: with payment banks, you can pay and receive money instantly with a few clicks from your phone without having to carry any cash.
- Offers: Payment banks often come with varied customer offers, such as cashback, coupons and discounts.
- No credit cards: Payment banks do not offer credit cards or NRI deposits.
- No loan benefits: You cannot opt for loans from your payment bank accounts.
- Technological issues: Sometimes payments and transactions can take longer due to technical issues or server problems.
- Fixed Deposits
Similar to a savings account, Fixed Deposits (FDs) offer assured returns on your deposits. However, it serves as a better alternative in terms of returns. Fixed deposits can also be a better option for diversifying your investments.
- Higher interest rates: Fixed deposits have a higher interest rate of up to 9.00% (small finance banks) for general users and of 9.50% for senior citizens (small finance banks), which is significantly higher than savings account rates. As a result, you can generate decent returns with higher capital security.
- Regular payouts: Fixed deposits also offer periodic payouts, which can help you earn a certain amount every month and manage your expenses.
- No market risk: Compared to debt funds and other investments, fixed deposits do not get affected by market fluctuations. Therefore, you can have a clear idea of the returns at the beginning of your investment.
- Penalty charge: Fixed deposits are not open-ended investments. Therefore, if you withdraw the money before maturity, you will be charged a penalty or get a lower interest rate on the deposited amount.
- Taxable return: The interest you receive from a fixed deposit gets added to your taxable income, thus adding to your income tax liability.
- Certificates of Deposits
Another high-yielding alternative to savings accounts is Certificates of Deposit (CD). CD is your way to go if you are not looking for high liquidity and want to park excess money for guaranteed high returns. Both fixed deposits and CDs work in a similar manner, except CDs offer a slightly higher rate of interest.
- High rate of interest: Certificates of deposits offer as high as 7.8% of interest rates, almost twice as savings account deposits.
- Insured deposits: The money you deposit as CD is insured if you opt for an RBI-insured bank or institution. Therefore, no matter how the market performs, you do not have to worry about losing your capital.
- Ladder option: Using the ladder technique, you can open several CDs with different periods of maturity. This allows you a certain amount of income at regular intervals. You can also re-invest it further to get higher returns.
- Liquidity: With certificates of deposits, you cannot access your money easily as the period of maturity is comparatively high. Therefore, it may not be the wisest option for emergency funds.
- Early-withdrawal charges: Unlike payment banks, or liquid funds, CDs charge an early withdrawal penalty if you take out the money before maturity.
- High Investment amount: Minimum investment amount for a RD is Rs. 5 lakh and you can opt for amounts in the multiple of Rs. 5 lakh. So it will not be feasible for everyone to invest in this option.
- Money Market Funds
Money markets funds are a type of debt mutual funds with a short maturity period of up to 1 year. These are short-term funds offered by banks and other financial institutions. These funds offer a better return with lower risks compared to stocks or bonds.
- Liquidity: Money markets offer short-term investment along with high liquidity. So you can withdraw the fund at very short notice through a hassle-free process.
- Higher returns: Money markets offer a high return on high tenures. Therefore, money markets could be a safe option if you do not require withdrawing the money right away.
- No Tax benefits: If you sell the units of these mutual funds 3 years from the initial investment, then It will be considered as STCG and taxed accordingly. No tax benefits are applicable.
- Default Risk: These funds are not insured and they are market linked. So they carry higher risk compared to a savings account.
There are alternatives to savings accounts based on interest rates, risks and liquidity. However, before opting for any option, you must evaluate your requirements, such as expected returns, capital, investment terms, and risk-taking capacity.
Once these factors are defined, you can select the suitable investment options to receive better returns than a savings account and diversify your investment portfolio.
Frequently Asked Questions
Why Should I Invest in a Debt Mutual Fund?
Debt mutual funds offer a much higher return than savings accounts with much lower risks than the stock market. As a result, it helps you diversify your portfolio and get a high return in the short term.
Which is the Safest Alternative to Savings Account?
Fixed deposits and certificates of deposits are safe alternatives as they are insured and do not get affected by market fluctuations. They also offer high-interest rates of up to 6-9%, almost double the savings account interest rates.
Why Should I Diversify My Investments?
You should diversify your investments to reduce total risk of the portfolio. For example, if you invest all your money in equity, then you will lose a large sum of money if the market falls. By diversifying your investments you are lowering the concentration risk.