A liquid fund is a good place to put money that you’ll need soon or money that you won’t need for a while. Unlike traditional mutual funds, liquid funds do not guarantee returns or principal. In comparison to fixed-term interest-paying products, these funds are a good short-term investment option.
You can withdraw your money the same day you deposit it. This allows investors to earn money on a daily basis. Source-based TDS does not apply to liquid funds. Unlike other instruments, TDS is not deducted upon redemption. For one-week or longer investments, “exit load” costs are typically waived. This lowers mutual fund fees. Read this detailed white paper to gain a more comprehensive understanding of stock exchanges subject.
What are Liquid Funds?
Treasury bills, commercial papers, government securities, and CDs are all investments made by “liquid funds.” Investors can park their money in these 91-day investments for one to three months.
Liquid funds are design for investors who require cash quickly. The volatility and risk of liquid funds are low as compare to large cap funds or small cap funds. They’ve primarily invested in high-quality products.
A liquid fund invests in debt and money market instruments with maturities of 91 days or less. T-bills, Commercial Paper, CDs, and Bank Term Deposits are among the debt products purchase by these funds.
How Does Liquid Funds Work?
The amount invested in these fund is based on the previous day’s NAV if funds are credited to the asset management company’s (AMC) collection account on time and the application is received on time. If a liquid fund buy order is sent on day X, the NAV from the previous day is used.
Debt interest is the source of liquid fund revenue. Their capital gains are negligible. Interest rates both drop and raise bond prices.
Because a liquid fund invests mostly in short-term securities, changes in interest rates have less of an impact on its market value. This means that liquid funds are unlikely to make or lose a lot of money. When interest rates rise, these funds outperform debt funds. While their interest earnings rise (because to the reinvestment of maturing short-term securities in new ones with higher rates). Their market prices fall less since capital losses are reduce (less sensitive to interest rate fluctuations).
There are risky and vulnerable to interest rate risk because they purchase debt assets. Changing interest rates may cause the price of debt instruments to rise or fall, influencing the fund’s daily returns. Credit risk exists with debt instruments. Purchasing government bonds and AAA-rated assets can assist lessen credit risk.
Types of Liquid Funds
Before investing, you should comprehend liquid fund. Because liquid funds operate differently, they are not suitable for all investors. When investing in liquid funds, keep the following in mind. As a liquid fund investor, you should be familiar with the following money market instruments:
Commercial Paper (CP)
CPs are issue by firms with high credit ratings and financial institutions. Commercial papers are unsecured investments that are sold at a discount and repaid in full. Investor return is the distinction.
Certificate of Deposit (CD)
CDs are comparable to fixed deposits. These can be obtain through charter banks. CDs, unlike FDs, cannot be cash in before maturity.
Treasury Bills (T-bills)
Every country government offers T-bills to collect cash promptly. Government-backed instruments are the most secure. T-bills pay less than other investments. This is the risk-free interest rate.
Advantages of Liquid Funds
Short-term investors benefit from these funds. These liquid mutual funds seek higher returns while safeguarding their clients’ investments. There are various advantages of liquid funds.
Risk-free
Liquid funds invest in government bonds that are consider as safe. There is almost no risk. They pay interest to investors since they are debt securities.
Cheaper at Cost
These instruments typically have a spending ratio of less than 1%. This low-cost structure maximizes the return to investors. Liquid funds are highly secured loan products that allow investors to receive their money right away.
Rapid Rescue
The investor can keep the securities till maturity or sell them at any time. He must pay a fee if he withdraws his money within seven days.
Liquidity
These are short-term investments that pay off quickly. Typically, redemption takes less than a day. It is simple to obtain these funds.
Better Returns During Inflation
Inflation benefits liquid assets. The RBI raises interest rates to keep the market from drying up during periods of excessive inflation. This increases the returns on easily sold assets.
Disadvantage of Liquid Funds
Despite the lower returns, the risk is insignificant. It’s a good short-term solution. Consider the disadvantages of Liquid Funds after studying their advantages.
Exit load
Even if there is no lock-in period, the user must pay a “exit load” if they sell the investment before a certain date. If an investor leaves within seven days, they must pay this fee. These charges are usually minimal.
Low Returns
Liquid funds do not provide as high a return as other investments. Although, investing in liquid fund implies missing out on the earnings of high-return funds.
How Are Liquid Funds Taxed?
These funds are tax in the same way as other mutual funds. The tax implications vary depending on how long you’ve kept your fund’s assets and whether you’re investing for growth or dividends. If an investor chooses dividends, they will be tax in accordance with the government’s rules.
In addition, liquid fund outperform fixed-rate, fixed-term debt-based investments after taxes and can be kept for a longer period of time. Liquid money in a growth strategy may be tax in the short or long term.
Long-Term Capital Gains
You must pay the 20% long-term capital gains tax (LTCG), which includes indexation, after three years (36 months). Although, capital gains are adjust for inflation using the government’s cost of inflation index (CII). This lowers the tax on capital gains.
Short-Term Capital Gains
You must pay short-term capital gains tax if you invest in a liquid fund’s growth plan and cash out within three years. Gains are also added to income and taxed in accordance with the tax bracket.
Should You Invest in Liquid Funds?
The similar strategy can be use to maximize a big sum of money. This could occur for a variety of reasons, including a bonus, asset sale, or bank deposit. Liquid funds are ideal for short-term capital storage before making a medium- to long-term investment decision.
Liquid mutual fund are an excellent way to invest a lump sum for the long term and frequently transfer it to another asset class, such as stocks (STP).
Similarly, someone can generate an income stream by putting lump sums of money in a liquid fund with a systematic withdrawal (SWP) option. These technologies make financial management easier.
How to Select a Liquid Fund?
Examine the offer document and analyses the fund’s past performance and portfolio quality before selecting a liquid fund. Examine the expenses of these funds. A lower expense ratio fund is more likely to earn higher returns.
Examine the fund’s credit and liquidity in the short and long term. Always go for a well-established fund that has no credit or cash flow difficulties. Moreover, the primary purpose for investing in a liquid fund is to avoid asset growth. Remember that liquid funds are, by definition, very liquid.
Conclusion
Liquid fund are one of the most secure methods of receiving money rapidly. For a variety of reasons, liquid funds are popular among institutional and individual investors. These funds are less influenced by interest rate volatility because they invest in short-term debt securities. Options for growth, income, and dividend reinvestment may help you invest. Liquid funds are ideal for making short-term investments.
