Liquid funds are easy-to-access and affordable short term investment options. They are considered safe, with low risk and offer flexibility in how you invest. These funds aim to protect your initial investment, ensure easy access to your money with modest returns.. Because of these features, people often see them as alternatives to short-term bank deposits.
Liquid Funds: The Bedrock of Stability
Imagine a pool where you can easily dip in and out whenever you need it. That’s the essence of liquid funds. These funds primarily invest in short-term securities like treasury bills, commercial papers, and certificates of deposit, ensuring high liquidity. They are a haven for investors seeking stability and quick access to their money.
To understand it better, liquid funds are a type of debt mutual fund schemes which invest in debt or money market instruments that mature within 91 days. Liquid funds are money market mutual fund schemes in which you can park your surplus funds for a few days to a few months. These funds don’t charge any fees when you enter or but charge a small fee when you exit within 7 days, making it easy to manage your cash by allowing you to come in and go out whenever you prefer. Liquid Funds are suitable for short-term goals or emergency funds.
Objective
Liquid Funds: As the name suggests, liquid funds offer better liquidity than other short term investment avenues. Usually, the redemption amount is disbursed to the investor’s bank account on a T+1 basis (T stands for transaction day) or the next working day, provided the transaction is received before the cut-off time.
Risk and Returns
Liquid Funds: Generally lower risk but offer modest returns. Liquid funds invest in less risky debt instruments, which leads to more stable and consistent returns compared to stocks.
Taxation
Liquid Funds: As per SEBI’s classification, liquid funds fall under debt funds, and their returns are included in the investor’s taxable income for the financial year. Regardless of your investment duration, taxes are levied based on the applicable tax rates for your total earnings in a financial year.
Exit Load
Liquid fund: Liquid funds do not charge any entry load and usually have a graded exit load up to six days and no exit load from 7th day.
Who can invest in Liquid Funds?
• Investors with a Short Investment Horizon:
It is suited for those with an investment horizon of less than 3 months or a very short duration.
• Bank deposit investors:
At comparable returns, liquid funds have flexible withdrawals and offer better liquidity when compared with short term bank fixed deposits. Bank Deposits generally penalise the customer on earlier withdrawal than the fixed deposit tenure.
• Contingency Fund Holders:
In liquid funds, investors can place money for emergency or contingency needs as they are available when needed. Liquid funds typically provide moderate returns on investment while providing safety and liquidity.
• Temporary Fund Parking:
Liquid funds are cash management products that aim to preserve capital with a low return rate. Investors can temporarily deposit a significant amount of money in a liquid fund, such as a bonus, the sale of real estate, or an inheritance until they decide on the investment for the corpus.
• Medium to Route Investments in Equity Funds:
Investors may first invest money in a liquid fund and then use Systematic Transfer Plan (STP) to gradually move in an equity mutual fund. This allows the investors to invest the money in equity markets in a staggered manner and take the benefit of rupee cost averaging in the short term.
Things to Consider Before Investing
Liquid funds are considered to be less risky but not risk-free. So before investing, you need to consider that:
• Returns cannot be assured:
Similar to all mutual fund products, returns from liquid funds are variable and not guaranteed. Before investing, always consider your risk tolerance.
• Credit Risk Existence:
While low-graded liquid funds are not immune to credit risk, investors should choose funds with high-quality portfolios. Unless the downgrade of your credit rating results in a loss of funds value.
• Not Wealth-Generating Products:
Liquid funds offer safety, liquidity, and modest returns, aligning with short-term financial goals rather than wealth creation.
Frequently Asked Questions
1. What are Liquid Funds and how do they differ from other types of mutual funds?
Liquid funds are a specific category within debt funds, primarily investing in short-term assets with maturities of up to 91 days. This characteristic distinguishes them from other mutual funds, such as equity funds or longer-term debt funds. The emphasis on short-term, highly liquid securities aims to minimize interest rate risk and provide investors quick access to their funds.
2. How do interest rate movements impact the performance of Liquid Funds?
In short-term assets, liquid funds are less affected by interest rate fluctuations than long-term bonds since they invest in short-term assets. It means liquid funds remain stable during a declining interest rate scenario, and assets are less impacted by interest rate fluctuations than long-term bonds.
3. Can one use Liquid Funds as an emergency fund or for short-term financial goals?
Yes, Liquid Funds work well as an emergency fund or for short-term money goals. Because they have low risk and let you take out your money quickly, they’re a great option for keeping extra funds that you might need in a hurry.
4. Are there any tax implications for gains made from investments in Liquid Funds?
Yes, there are tax implications for gains from investments in Liquid Funds. While dividends earned from mutual funds, including liquid funds, are tax-free, capital gains may attract taxes. First, short-term capital gains, realized on investments for up to 3 years, are taxed at the investor’s applicable income tax slab rate. On the other hand, long-term capital gains from liquid funds, realized after holding for more than 3 years, are taxed at a rate of 20%, with the benefit of indexation. Investors should consider these tax implications when planning their investments in liquid funds.
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