The short answer? No. For the long answer, let’s understand how liquid mutual funds work and how liquid funds are taxed.
Due to their flexibility, mutual funds have become extremely popular among investors. Thanks to the availability of different fund types that suit investors with varying risk profiles, MFs are becoming more popular. Investors today are interested not only in the best fund to invest in, but also in the type of fund that is the most cost-effective to invest in.
However, investment decisions don't end at that. Besides the expense ratio, you also must pay taxes on your earnings from mutual funds. But not all funds are taxable. Let’s look at the different mutual fund options and who should invest in them.
Liquid funds are debt mutual funds that invest in money market instruments with a short-term maturity of up to 91 days. These assets include government securities, commercial papers, certificates of deposit, treasury bills, repos, call money, etc.
The returns on a liquid fund are based on the market price of these securities. These returns are more stable than other debt funds as prices of short-term securities fluctuate less than long-term bonds.
If you have a short-term investment horizon and want to make the most out of your money, then liquid mutual funds are ideal for you. Here's how-
A liquid fund allows you to hold your investment for as long as you want. This way, you can easily enter and exit the fund while enjoying safe returns that are linked to the market. But remember, if you redeem the funds within seven days, you'll have to pay a small exit load.
Liquid funds are debt funds with low risk. They focus on generating steady returns while keeping the principal amount safe. This keeps their value stable across other interest rate cycles in the market.
The expense ratio forms a significant component in the final mutual funds' calculation. But the expense ratio of most liquid funds is below 1%. This is because they're not managed as actively as other debt funds. This reduces your cost of investment while maximising the returns.
As liquid funds invest your money in highly liquid securities that have a low default rate, they process your redemption request instantly or within one working day. Therefore, in the event of an emergency, you'll not have to wait for days to access the funds.
Investing in liquid funds offers several advantages. Key advantages include:
Liquid funds are suitable for the following types of investors:
- Short-term investors
Liquid funds are ideal if you have a short investment horizon, typically ranging from a few days to a few months. invest in short-term money market instruments like treasury bills, commercial papers, and certificates of deposit, which offer relatively stable returns with minimal interest rate risk.
- Investors who invest in bank deposits
If you only invest in bank deposits, you can benefit from liquid funds due to potentially higher yields. While bank deposits are relatively safe, liquid funds offer competitive returns with added flexibility. They also provide the advantage of immediate redemption and typically do not have a lock-in period.
- Investors who want to maintain emergency funds
Liquid funds are ideal for investors looking to maintain an emergency fund. These funds can help cover unexpected expenses without compromising on returns. Moreover, liquid funds offer quick and easy access to funds, ensuring you can withdraw money whenever needed without any penalties or waiting periods.
- Temporary parking of funds
You can use liquid funds as a temporary parking space for funds. Whether you're waiting for an investment opportunity or in between switching to a different investment, liquid funds provide a safe haven with stable returns.
- Medium-term investment route
Some investors use liquid funds as a bridge between equity investments and safer options. When transitioning from stable investments to equity funds, liquid funds serve as an intermediary step. They provide a buffer against market volatility while offering better returns compared to traditional savings options.
Now that we have understood the meaning and benefits of a liquid fund, the big question is- are they tax-free? Taxes are an important factor to consider for mutual funds calculation. When you invest in liquid funds, you earn dividends and capital gains.
While your dividend income is tax-free, the income from capital gains is taxable. You will have to pay taxes on short-term or long-term capital gains based on the holding period.
When you invest in a liquid fund for up to three years, you'll earn short-term capital gain when you sell or redeem the units. For your mutual fund calculation, add the profit from the fund to your income. You will now have to pay taxes as per the rate of your income tax slab.
When you invest in a liquid fund for more than three years, you will earn long-term capital gains. Before calculating the capital gain, you will receive the benefit of indexation. This means the fund will increase your purchase price to adjust for inflation before the final mutual fund calculation. Following this, your long-term capital gains will be taxable at a flat rate of 20%.
Although liquid funds provide you with great flexibility and a low cost of investment, they are not entirely tax-free. This makes them unsuitable for you if your primary objective is to save tax. But if not liquid funds, then what?
Well, the answer is ELSS mutual funds. These are open-ended funds that invest a majority of their corpus in equities and equity-related assets. ELSS allows you to make investments in a Systematic Investment Plan or SIP. With ELSS, you can avail of a tax exemption of up to Rs. 1.5 lakh on your annual income under Section 80C of the IT Act.
Taxes play a significant role in mutual fund calculation. While MFs are an excellent and safe investment instrument, taxes can reduce their returns. With ELSS funds, you can not only increase your wealth but also enjoy taxation benefits. Additionally, long-term capital gains on ELSS up to Rs. 1 lakh are also exempt from income tax.
ELSS also offers higher returns than FD or PPF, but you must have a high-risk appetite to invest in it. You can download the Tata Capital Moneyfy app to compare investment options and manage your portfolio smoothly.
Liquid funds are considered relatively safe because they primarily invest in short-term debt securities, minimising risk. However, like all mutual funds, they are subject to market risks.
No, liquid funds do not have a lock-in period. You can redeem your investments anytime without any penalty.
Some liquid funds may have an exit load if redeemed within a very short period after investment, typically up to 7 days. However, many liquid funds do not impose an exit load.
Liquid funds offer higher liquidity and potentially higher returns than fixed deposits over the short term. However, they also carry market risk compared to the guaranteed returns of fixed deposits.
Liquid ETFs are taxed similarly to debt mutual funds. Short-term capital gains are taxed at applicable slab rates, and long-term capital gains are taxed at 20% with indexation benefits.
Yes, liquid funds are subject to taxation. Short-term capital gains are taxed at applicable slab rates, while long-term capital gains are taxed at 20% with indexation benefits.
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06 September 2024
7 mins read
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