Hi folks! Today, we will be discussing Liquid Funds. But how can funds be in the liquid state? Is that the first question that comes into your mind? Don’t worry, we have got you covered. I had the same approach when I first heard this term. Here, in this article we will explain in detail what are liquid funds in India, why are they called so and how can you invest in these funds. Let’s go ahead.
Liquid funds are a sub-category of Debt funds. Moreover, they have a short term duration of up to 91 days. Debt funds invest in assets or securities that generate fixed interest and a fixed maturity period. These are divided into 16 categories ranging from overnight funds to long term funds of up to 7 years, one of which is Liquid Funds. The word liquid here means easy to sell or convert into cash.
What are liquid funds?
Liquid funds are thus debt funds that invest in highly liquid money market instruments and debt securities that generate fixed interest for the short term. These instruments or securities maybe treasury bills, commercial papers, certificates of deposit, government securities, corporate bonds, etc.
They are short term i.e. they have a maturity of up to 91 days or three months.
Their Net Asset Value (NAV) is calculated for 1 year.
These funds provide a high degree of liquidity and capital safety that one can get their withdrawals processed easily within 1 day.
This type of debt fund has the lowest interest-rate risk due to its short-term nature thus being less volatile.
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How Do Liquid Funds Work?
1. The fundamental objective of these funds is providing high liquidity and capital protection to the investors.
2. The fund manager carefully selects and invests in higher rate debt securities that mature within 91 days scheme.
3. He/she will always ensure that the average maturity of the portfolio does not exceed three months
4. Why? Because shorter maturity ensures fewer fluctuations hence least affected by the change of interest rates.
5. Moreover, comparing the maturity of individual securities with the maturity of the portfolio helps the fund managers to provide higher returns.
Types of Money Market Instruments
Certificate of Deposit (CD):
a) These are term deposits offered by scheduled commercial banks.
b) Certificate of Deposit is very similar to Fixed Deposits except for the fact that one cannot withdraw CD before the expiry of the term.
Commercial Paper:
a) Issued by primary dealers, large corporations, and All-India financial institutions with a high credit rating.
b) Also called Promissory notes.
c) These are unsecured instruments issued at discounted rates and redeemed at face value.
Treasury Bills:
a) Issued by the Government of India.
b) In order to raise money for a short term i.e. up to 1 year.
c) Safest of the three, guaranteed repayment at a later date.
d) The rate of return or risk-free rate is the lowest of all three.
Who Should Invest in such funds?
1. The ideal investor for such a fund would be one who consequently has a lot of idle cash or surplus money looking for a short term investment scheme.
2. Moreover, these are just like your everyday savings bank account but will provide you way better returns with relatively lower risks
3. Also, investors who are thus looking for investing in equity funds can start with liquid funds. This will be their medium to systematically transfer to equity funds in a step by step manner over a stipulated period of time
How to Invest in Liquid Funds?
1. Firstly, sign in to Investify.in
2. Secondly, enter your requirements like the amount to be invested, a period of investment, etc.
3. Thirdly, complete your e-KYC.
4. Lastly, select and invest in your preferred choice of mutual funds that is most suitable to your needs.
Things to Consider as an Investor
Risk
a) Firstly, liquid funds are investments with low-risk.
Why? Because risks in mutual funds are caused by fluctuations in Net Asset Value (NAV). The money market instruments in liquid funds have a maturity of up to 91 days only. Thus, its NAV is very less susceptible to change due to relatively steady interest rates.
b) However, they are not completely risk-free.
Why? If the credit rating of any underlying money market instrument falls down suddenly, subsequently the NAV will fall down too.
Return
a) Secondly, returns generated from liquid funds are in the range of 7%-9%.
b) Relatively much higher than savings bank accounts with the same amount of liquidity which is only 4%
Expense
a) Moreover, in order to manage your investment, liquid funds charge a small annual maintenance fee.
b) This fee is thus a percentage of the total securities of the fund also known as the expense ratio
c) Liquid funds charge a very low expense ratio. SEBI has also mandated the upper limit to be 1.05% only
d) Lower the expense ratio, higher the gains. Thus, debt investors prefer this fund.
Investment plan
a) Liquid funds thus have a 3-month investment window.
b) Also, being short term in nature, liquid funds ensure the realization of maximum potential from the underlying securities or assets
Emergency Fund
a) They also give a reasonable return. Also, the risks involved are very low. Thus, they find use as emergency funds.
b) These are subsequently highly liquefiable in case of emergencies
Tax
a) An important point often missed out henceforth is Taxation
b) The capital gains thus earned from these investments in debt funds are taxable.
c) Also, the rate of taxation directly depends on the holding period of the investment.
d) If the liquid fund investment is held for more than three years, it comes under long term capital gains (LTCG) and taxed at 20% after indexation. It means that all dividends from the funds are added to the total income and then taxed.
e) However, if the liquid fund is held less than or equal to three years, it comes under Short Term Capital Gains (STCG) and is free of taxes.
Top 10 Liquid Funds in India
One needs to subsequently carefully analyze the funds from different aspects keeping in mind the factors to be considered before investing in liquid funds as explained above.
The following table consequently represents the top 10 liquid funds in India based on the past five-year average returns.
Investors may finally choose the funds based on a different investment window like one year or ten years returns. They may also include other criteria like financial ratios too.
Conclusion
Thus, we understood what Liquid funds are all about and how it works in the world of investment. We saw its similarity with a savings bank account and understood its benefits over the other. A lot less risky with better returns and its short term nature makes liquid funds very attractive to debt investors. So gear up and safeguard your future. Happy investing!
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