Investment in mutual funds has gained immense popularity among Indian investors. While mutual fund investment has attracted tons of new investors, yet there are few investors who refrain from investing in mutual funds. Many investors think that mutual fund investment is a long-term investment strategy, if they invest, their money will be locked and there will be no liquidity. Moreover, they cannot get their money at the time of emergencies, and if they redeem they will receive a low return.
To overcome these hurdles, mutual fund investment has a kind of fund known as Liquid Fund. This aims to provide high liquidity and safety of the capital to investors, that is the investor has complete access to their funds and they can redeem it whenever they need it.
Liquid funds are high liquidity funds that invest money in debt and money market instruments. These funds have a maturity period of 91 days. These are the safest funds amongst all other mutual funds, owing to their extremely low lending duration. Liquid funds are suitable for depositing money aside for emergencies. In liquid funds, you can invest money for a short duration and withdraw them whenever required.
1. Interest Rate
Investors who put their money in liquid funds tend to earn higher returns. The rate of interest on them is comparatively higher when compared to the interest offered by most of the savings accounts.
2. Dividends Earned
The dividends that investors can earn through liquid investments are subjected to a tax called the dividend distribution. Even after tax, the dividend that investors earn on liquid funds is still better than returns offered by savings accounts.
3. Tax Structure
Liquid investments provide tax benefits to its investors. The tax applied to long-term gains is 20% and is inclusive of indexation. On the other hand, for short-term capital gains, the gain is added to investors’ income, and the regular rate of prevailing tax is applied to it as per the investors’ tax bracket.
Investors can withdraw whenever they are in the need for cash. At the same time, investors can invest a big amount in liquid funds when they have extra money at hand. The fact that there is no fixed minimum investment horizon in liquid funds makes liquid fund investments even more flexible in nature.
1. Low Risk
A liquid fund is a low-risk debt fund which focuses on providing safety of principal and steady returns. Thus, the value of a liquid fund is reasonably stable across multiple interest rate cycles in the market.
2. Low cost
Liquid funds are low-cost debt funds as they are not actively managed like other debt funds. Generally, most liquid funds operate with expense ratios below 1%. This low‐cost structure enables them to increase the effective return to the investor.
3. Protection against inflation
liquid funds are your best bet if you want protection against inflation. Since the Reserve Bank of India raises interest rates during inflationary times, you will be benefited from that.
4. Quick Redemption
Redemption requests are processed within a day; few funds even offer an instant redemption facility. This is possible as liquid funds are invested in highly liquid securities with a low default probability.
Selecting a liquid fund is a difficult task, however, one can use basic parameters to choose.
Below are the few basic parameters used to select liquid funds:
1. Historic Returns
Past Performance of the fund and the track record of the AMC has to be analyzed.
2. Credit Rating
The highest rating is AAA. Higher credit rating denotes fewer chances of default, thus less risky.
3. Portfolio Allocation
Scheme’s portfolio and instruments in which allocation has been done have to be monitored.
4. Average Maturity of the Portfolio
Investors should have a look at the average maturity period of the overall investment portfolio. If it is 3 months or less than that, then it is a good fund to invest in. A short term maturity period assures that the portfolio is immune to interest rate fluctuations that occur in the long term.
5. Fund Objective
There are multiple plans like growth plans, daily dividend plans, weekly dividend plans, and monthly dividend plans. Plans have to be chosen based on your risk appetite & fund requirement. This helps you to meet emergency expenses and shield yourself from the volatility of equity investments.
Liquid Funds are taxed rely on the holding period of invested capital:
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Instant redemption feature is available for many liquid funds offered by different AMCs, wherein an amount up to ₹50,000 can be instantly withdrawn, and it reaches the bank account of the investor in a few minutes.
Liquid Funds give almost similar returns as short term FDs. However, they can be an excellent alternative to FDs for two reasons. One, there is no lock-in period you need to commit to, and second, you don't need to pay any penalty if you withdraw after 7 days of investment.
No. You can redeem anytime you want. There is no lock‐in period in liquid funds.
Yes, but only if you redeem within seven days of investing. After that, you don't have to pay any exit load.
Liquid Funds do not provide ensured returns. However, they do provide very stable returns, owing to the nature of their portfolios. At present, liquid funds can be expected to provide annualized returns within the range of 6% to 7%.
Yes. You can start a SIP in a liquid fund. You can pick how frequently you want to invest, and money will get auto‐deducted from your account and invested.
As Liquid Funds lend to good companies for an extremely short duration and reduce the risk they are considered as safest mutual funds. The risk of losing money is almost zero if you stay invested for some amount of time.
Yes, Liquid funds are taxable. If the liquid fund investment is held for more than 3 years, it is subjected to long term capital gains which is taxable at 20% with indexation.
As a liquid fund invests only in short term securities, it's market value doesn't respond much when interest rates alter in the market. This refers that liquid funds do not have significant capital gains or losses.
As per the data from Value Research, many large liquid funds have actually delivered negative returns. Ultra Short Duration Funds have given -0.48%, market funds have given -0.51% and low duration funds have delivered -0.91%.