Rather than parking your cash in a savings account, why not invest it where it can generate higher returns? A liquid fund is such a choice. The risk in it is minimal, however not totally missing.
If you have short-term goals to fulfill, read this guide on liquid funds to understand everything about putting resources in liquid mutual funds.
Knowledge Source #1: What Are Liquid Funds?
These are open-ended debt mutual funds that mainly invest in short-term money market instruments and have maturity up to 90 days.
Money market instruments can include Certificate of Deposits (CDs), Term Deposits, Commercial Papers, Call Money, Treasury Bills and so on.
These funds, as the name suggests, are highly liquid in nature. With a short time-frame, these funds attempt to reduce risk. However, they are not entirely risk-free.
Knowledge Source #2: How Do Liquid Funds Work?
Liquid funds aim to provide a high degree of liquidity and safety to investors. For this reason, your money is allocated by the fund manager in high-credit quality debt instruments. Additionally, it is ensured that the average maturity of the portfolio is up to 3 months.
Thus, the returns generated by the fund stay slightest affected by the overall interest rate changes in the economy.
Knowledge Source #3: Who Should Invest in Liquid Funds?
If you have substantial idle cash and are looking for short-term investment vehicles, liquid funds are meant for you. Also, these funds are suitable for risk-averse investors.
If you have short-term goals, then you can park your money into such funds and earn better inflation-adjusted returns. For instance, if you are planning a family vacation at the end of the year, then you can start a monthly SIP in liquid funds and build your vacation corpus.
In addition, these funds can be used to park a portion of your contingency fund.
Knowledge Source #4: Things to Consider as An Investor
Basically, the risk in liquid funds relates to fluctuations in the NAV (Net Asset Value). Although for these funds, the NAV doesn’t fluctuate too frequently (as the underlying assets have shorter maturity of 60-91 days), however, there might be chances of a sudden drop due to the downgrade of the credit rating of any underlying security. In simpler words, liquid funds are not completely risk-free.
Liquid funds have generated returns in the range of 7 percent to 9 percent historically. Thus, the returns generated are higher than 4 percent returns obtained on savings bank account.
The fee charged to manage these funds is called an expense ratio (2.25 percent mandated by SEBI).
Knowledge Source #5: What Are the Benefits of Investing in Liquid Funds?
Professional Management of Funds
As even debt investments are vulnerable to risk, they must be managed carefully. Hence professional fund managers are involved in mitigating the risks and generating positive returns.
As fund managers understand the larger picture of the economy, they align and realign your debt portfolio based on the dynamic interest rates and changing macro environment.
If these managers see any interest rate risk on the holdings, they take a timely call, which, otherwise, is difficult for an individual investor.
Better Post Tax Returns
Liquid funds enjoy some favourable tax treatment, thus helping you to increase your net returns. Tax returns on the liquid funds depend on your holding period. If the holding period continues to be more than three years, liquid funds retain their advantage.
Your short-term capital gains (STGC) from liquid mutual funds are taxable as per your tax slab. Whereas long-term capital gains (LTCG) are taxed at the rate of 20 percent after indexation.
Accessibility of Unavailable Debt Securities
Some securities, like Government securities, have a very high-ticket size. This means that such investments are out of the reach of an individual retail investor as the minimum investment requirement is very high.
However, liquid funds pass on this benefit to you by investing in such securities, thus, widening your choice of investment.
The Bottom Line:
Hope that this guide was a meaningful read for you. Last but not the least, while selecting a fund, keep your financial goals, risk appetite and investment horizon in mind.