Ask any seasoned investor, and they will tell you that mutual fund investments are a long-term game. But what about investors who desire quick returns or want to park their investments for only a few months? Well, they can consider investing in liquid funds.
In simple terms, liquid funds are debt mutual fund schemes wherein investors can invest money in fixed-income instruments that mature within 91 days. Investors with ample surplus funds invest in these instruments to park their funds for a few weeks and earn returns.
Besides, investing in liquid mutual funds is fairly easy. The NAV is calculated for 365 days, and the withdrawals get processed within 24 hours.
These funds also face the lowest interest risk, making them an excellent investment choice for beginner investors or those with a low-risk tolerance.
Now that we’re clear on what are liquid funds, let’s understand how they work.
1. Reduced Risk
Liquid funds primarily invest in short-term debt instruments, which have lower market volatility compared to equity or long-term debt investments. These funds maintain stable value even during market fluctuations, making them a safer option for risk-averse investors.
2. Flexible Tenure
Liquid funds offer a flexible tenure where investors can stay invested as long as they want to and exit easily. Although a small exit load applies to redemption within seven days, the structure is still flexible, allowing investors to get handsome market-linked returns.
3. Cost-Effective
Liquid funds usually have low expense ratios, making them a cost-efficient investment option. This is because these funds require less active management than other debt funds.
4. Easy Redemption
Investors can redeem their units quickly, often receiving the proceeds within 24 hours. They are highly accessible and convenient when quick liquidity is required.
First, the fund manager observes the debt securities and selects high-quality ones according to the mutual fund scheme’s mandate. Next, the manager checks the portfolio's maturity and ensures it isn’t over 91 days.
Remember, the short maturity period ensures that the fund does not experience drastic interest rate fluctuations, even in a volatile market.
Once the maturity period is verified, the fund manager matches the maturity of the individual securities to that of the portfolio. Then they try to employ strategies offering better returns.
With what is liquid mutual funds and how they work out of the way, let’s look into the various factors investors should consider before investing in them.
1. If you're looking to make short-term investments with idle cash, liquid funds present a great opportunity as they offer better returns than savings accounts or current account.
2. Investors looking to transition into equity funds can also invest in liquid funds. The stability and liquidity offered by liquid funds make it an attractive option to start with for investors who want to move to higher-risk equity funds gradually.
Liquid mutual funds are a suitable choice under certain conditions:
1. Temporary Parking of Funds: If you have surplus cash you don't plan to use immediately, liquid funds offer a safe place to park the money until needed.
2. Quick Access to Funds: These funds provide instant liquidity, making them a great option if you need quick access to cash without locking it in. They are excellent for meeting short-term financial needs.
3. Safety and Predictability: With low-risk investments in high-quality, short-term instruments, liquid funds offer predictable returns, making them ideal for conservative investors seeking stability.
4. Potential for Higher Returns: While liquid funds do not generate exceptionally high returns, they offer better returns than savings accounts, allowing investors to earn more on idle cash without significantly increasing their risk exposure.
You can earn regular dividends and capital gains from your liquid fund investments. While the dividend income does not attract any tax, the capital gains or redeeming the fund units are taxable as follows-
1. If the investor redeems the liquid fund units after holding them for up to 3 years, the gains are considered short-term capital gains and taxed as per your income tax slab.
2. If the funds are redeemed after being held for more than 3 years, the gains are taxed at 12.5%.
#1. Risks
Liquid funds are some of the lowest-risk investment avenues. Given they have a short maturity period of 91 days, they do not witness market rate or interest rate fluctuations. That said, the credit rating of individual debt securities can change anytime. If they drop, the NAV drops and affects the returns from the fund.
#2. Returns
Liquid funds are known to offer better interest rates than regular savings bank accounts. The average rate is roughly between 7% p.a. to 9% p.a.
#3. Investment plan
Liquid funds serve those investors best that have a solid investment plan. After all, they behave as a place to park surplus funds, and are low risk, low-return investments.
#4. Expense ratio
Investors will get charged an annual fee for liquid funds for the fund management services.
Note that the expense ratio for these funds is lower. Besides, most investors easily hold the securities until maturity. This means there are no additional charges on liquid funds either.
In simple terms, liquid funds do not incur expenses due to excessive buying and selling of debt securities. This keeps the expense ratio low.
With all this information in your hands, you need not spend another moment typing “What is liquid mutual funds” or “What is liquid fund in mutual fund” into your web browser. If you’re someone who prefers high liquidity or are a low-risk investor, you can begin investing immediately.
Tata Capital makes investing even easier through Moneyfy. Through the service, investors can invest and track their investments from anywhere. Visit the Moneyfy website to learn more, and if you’re interested in managing your funds on the go, download the Moneyfy app today!
Liquid funds typically generate returns similar to FDs. However, they can be a good alternative as liquid funds do not have a lock-in period and don’t require you to pay any penalty for withdrawing the investment after 7 days.
You can invest in liquid funds through a Systematic Investment Plan (SIP), allowing you to contribute regularly and benefit from the flexibility and liquidity of these funds.
No, liquid funds do not have a lock-in period. You can redeem your investment anytime.
Liquid funds generally have no exit load after 7 days. However, redemptions within the first 7 days may attract a minimal exit load.
Liquid funds are considered low-risk, as they invest in great companies for a short duration that minimises the risk.
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27 September 2024
6 mins read
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