If you are in the habit of keeping large amount of your surplus cash in your savings bank (SB) account, you are losing on the interest you could have earned by investing surplus cash judiciously in other investment instruments. Now, with the interest rate on SB accounts reduced further by the banks from around 4% previously down to around 3.5% currently, the loss is would be all the more higher.
The main reason for having an SB account is to avail the facility of instant liquidity. One can withdraw money from the SB account anytime, anywhere and from any ATM machine across the country. This facility of instant availability of money helps take care of any emergency requirement of funds and near-term expenses as and when required. Hence, a reasonable amount of money needs to be kept in the SB account to meet such unexpected contingencies and regular expenses. Apart from providing such unmatched liquidity, the SB account also provides modest return in the form of interest on the amount in the account. This is definitely better than keeping the surplus cash idle at home.
However, keeping surplus cash in SB account which is way above the family’s reasonable requirement is not a prudent choice. The financial cost (in the form of loss of interest) and tax liability can be substantial if the amount kept is large enough. The alternative is to park surplus cash in liquid funds or arbitrage funds where the returns are higher than SB account. The rate of return on liquid and arbitrage funds varies between 7-8.5% for a period ranging from one to three years. Hence, the difference in return between these funds and SB account is substantial . These funds also offer tax benefits, which further enhances the rate of return on the funds. Of course, the liquidity is not as high as an SB account since the redemption may take two to three days.