The mutual fund industry has provided investors with various interesting options to invest in. Liquid funds are one of them. With a smaller maturity period, high liquidity, and promise of returns, these debt funds are quite popular among investors who look for safe investment options other than bank deposits and FDs.
Let’s deep-dive to understand liquid funds meaning, the benefits of investing in liquid funds, and how to invest in liquid funds.
This article covers:
- What are liquid funds?
- Features of liquid funds
- How do liquid funds work?
- Things to remember before investing in liquid funds
- Key benefits of liquid funds
- Taxation rules regarding liquid funds
- How to invest in liquid funds?
What are liquid funds?
Liquid funds are a category under mutual funds that invest in short-term but high-quality debt instruments and money market securities such as treasury bills, government securities, and certificate of deposits, for a maximum period of 91 days.
Those investors who have idle cash and look for investing in short-term investment havens may consider parking a part of their funds in liquid funds. These are low-risk mutual fund schemes that invest in short-term fixed interest generating investments. The Securities and Exchange Board of India (SEBI) has specified a blue colour label (which indicates low risk) for these instrument funds.
Features of liquid funds
Liquid Funds invest in short-term debt funds that are high-rated securities, which make these funds less risky.
Investment in these funds doesn’t have any lock-in period. Investors can withdraw their funds whenever they want. Additionally, there are no entry or exit loads applicable on liquid funds.
Funds are allocated as per the investment goals of the investors in products with a maturity period averaged at less than three months. That is how liquid funds bring in liquidity.
These funds charge low annual fees, which range between 0.3% to 0.7%.
The minimum amount for investment in schemes varies from one scheme to another.
How do liquid funds work?
Like in other mutual funds, fund managers collect funds from different investors and sell them units of the liquid fund.
The fund managers then invest the pooled capital in carefully chosen debt instruments that have only up to 91 days maturity period. They may be debt or money market instruments such as certificate of deposits, T-Bills, etc., that are short-term investments, in accordance with SEBI norms. Note that the investment may be made in different avenues of varying maturity periods.
As per SEBI norms, a minimum of 20% of the total corpus should be invested in cash and cash equivalent avenues. This investment in the most liquid instruments is intended to meet quick obligations. Liquid funds may invest in listed commercial papers with an overall exposure limit of 20% in this segment.
Liquid funds are restricted from investing in risky assets.
Short-term debt securities are not affected by the long-term relationship between interest rate and the market price of securities. Thus, these securities usually provide returns that outperform other debt instruments’ returns.
Net Asset Value or NAV is an important element of liquid funds. For mutual funds, NAV is generally calculated for business days, but in liquid funds, NAV is determined for all days, including weekends.
Things to remember before investing in liquid funds
Returns on funds: Before investing in liquid funds, it is important to analyse returns. While there is no lock-in period, the maturity period for the investments that the fund puts your money in is up to three months. You may want to analyse the returns that were generated by the scheme you are interested in for a longer duration to have a better understanding of the scheme’s direction.
Portfolio diversification: To avoid the risk to a greater extent, select a fund with greater diversification. This can help in case the markets flip or there is a black swan event.
Expenses and charges of funds: Generally, returns on all liquid funds are quite similar. Due to this, identify a fund with low annual charges, initial expenses, and other fees. By evaluating these parameters, you can select a good fund for investment.
Key benefits of liquid funds
The highlight feature of liquid funds is the liquidity they provide. There is no lock-in period or entry/exit loads in these funds. They invest your money in short-term instruments with maturities up to 91 days only.
Stable rate of return
Stable returns remain a major attraction for these funds. Historically, liquid funds have provided returns in the range of 7-9%; though interest rates are much lower, they should still suffice to provide enough liquidity to beat inflation.
Investment in high-rated securities
Liquid funds allocate collected funds in high-rated securities. High-rated security refers to financial securities which secure good ratings from credit rating agencies like Moody’s, Credit Analysis and Research Ltd (CARE), Credit Rating Information Services of India Limited (CRISIL), etc.
Taxation rules regarding liquid funds
Liquid funds are short-term debt mutual funds, hence inviting short-term capital gain tax.
Considering they are short-term investments, however, this may not necessarily apply. Nonetheless, should the investor choose to remain invested for more than three years, then they are required to pay tax on the capital gains realised as is applicable to debt mutual funds at the tax slab of the investor.
How to invest in liquid funds?
Subscribing to liquid funds is the same process as subscribing to any other mutual fund. An investor may directly approach the mutual fund house offering the scheme, or invest through a broker. A Demat account is not a compulsion to invest in mutual funds. Investors, however, need to complete KYC formalities to trade mutual fund units.
Liquid funds are a type of debt funds that allow investment in money market instruments like promissory notes, commercial papers, treasury bills, and other short-term debt instruments. These funds provide benefits of high liquidity and stable returns to investors and act as and safer investment avenues for the short-term. To invest in liquid funds, investors may approach any mutual fund agency and stockbroker. Understand your financial goal and risk appetite before investing in any type of fund, scheme, or instrument.
Apart from mutual funds you can invest in equities too. If you are new to the investment field and are looking for a shubh muhurat to start your investment journey, you can invest during this year’s Muhurat Trading session. This session is considered auspicious in Indian stock market. You may start by screening stocks on Tickertape’s Screener and adding them to your watchlist.
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