Liquid Funds come under a particular category of mutual fund scheme that enables individuals to invest in money market and debt securities and attain maturity as quickly as 91 days. The investment carried out through these funds comes under the category of debt instruments, wherein its residual maturity is less than 91 days during the investment period. This includes Certificate of Deposits (CDs), Commercial Paper (CPs), Bank Term Deposits, and Treasury bills (T-bills). Learn what are liquid funds, their benefits, and how to invest in them.
What is Liquid Funds?
The amount of money invested in a liquid mutual fund before 2:00 pm on a trading day is considered as NAV of the previous day. This is considered as long as the fund credited to the collection of Asset Management Company (AMC) receives the collection before 2:00 pm. And the AMC branch receives the application in time. Hence, if the purchase transaction is done on a particular day, the application will be considered a day prior. The same goes for redeeming the amount credited to the investor account. An amount for redemption if received on a Friday before 3:00 pm, gets processed on Sunday, and the payout takes place on Monday.
For a liquid fund, the earning source mainly comes through interest income that comes from debt holding, and that small amount of income is generated through capital gains. In simple terms, when the interest rate falls, the bond’s price goes up and vice versa. When the liquid fund is invested primarily in short-term securities, the market value changes along with the fluctuation of the interest rates. This proves that liquid funds do not incur any significant loss or gain of capital over time, making it a safe option.
In a financial environment with an increasing interest rate, liquid funds usually outperform than other debt funds. This is because, as the latter’s interest-earning raises their value in the market takes a toll for a certain amount of time because of low capital loss.
How Does Liquid Mutual Funds Work?
It is essential to know how liquid mutual funds work and how they generate returns. Generally, the liquid fund holds short-term securities of good quality credits and is highly liquid. These funds can only list in commercial papers and have a 20% exposure limit in any sector, and don’t have permission to invest in risky assets, as mentioned by SEBI.
Also, the liquid funds are supposed to hold 20% of assets in the liquid products such as money market securities and more.
The liquid funds earn through the various interest payments on debt holdings and capital gains. Liquid funds only invest in short-term securities, so the market value doesn’t respond much when the interest rates change.
What are the Features of Liquid Funds?
Liquid funds are debt mutual funds that primarily invest in short-term money instruments. Here are some of the key features offered under liquid funds:
- No Exit and Entry Load: These funds do not have any exit or entry load, given that they are highly liquid in nature.
- Low Annual Fee: Liquid funds generally feature a low annual fee.
- Return on Investment: Liquid funds help fetch a good rate of return on the amount invested. With the rise of inflation, RBI also increases the rate of interest.
- Variable Investment Amount: The minimum investment amount under liquid funds varies with the scheme.
- Easy Liquidation: Withdrawals from liquid funds can be accomplished in just one day, which is a relatively short period of time.
- Convinience: Under liquid mutual funds, you can invest in multiple ways. These include growth plans, dividend plans, weekly dividend plans, and monthly daily dividend plans. Depending on the needs for liquidity, investors can pick the plan they would like to invest in.
Who Should Invest in Liquid Funds?
Following are the individuals who can opt to invest in Liquid Funds:
- Individuals who are interested in short term investment with a horizon of 3 months
- Individuals who are interested in investing in a bank deposit
- Investors who are interested in keeping contingency funds
- Individuals who intend to park their funds temporarily
- Investors possessing Medium to Route investments in Equity Funds
When To Invest In Liquid Funds?
Knowing when to invest after understanding the meaning of liquid funds is essential. For those with idle cash who want to make short-term investments that yield a better return than a regular savings account, liquid funds are the best option. If you want to invest extra money for a short time, say, up to three months, liquid funds are best. You can better realise the full potential of the underlying securities with such a short time horizon.
What Factors Should You Consider Before Investing in Liquid Funds?
After understanding what is liquid funds, one must have a thorough understanding of how liquid funds operate before investing. Since liquid funds operate somewhat differently from other investment options, they may not be the best option for all investors. Here are some factors you must consider before investing in Liquid funds:
- Risk: In mutual funds, the volatility in the Net Asset Value typically poses the greatest risk (NAV).
- Cost: An expense ratio, also referred to as a fee, will be charged for managing the liquid fund’s funds.
- Investment Horizon: For people looking to invest excess cash for a relatively short time—up to three months—liquid funds are a good option.
- Financial Goals: Liquid funds help build an emergency fund. These funds not only aid in increasing profits but also make it simple for investors to withdraw money in times of need.
- Returns: Liquid funds are known to produce positive returns.
- It is an efficient instrument that can be used to park or invest money for a limited or a short period which could be a few weeks or even a month. Like every other mutual fund, the liquid fund also does not have a complete guarantee of return of the investment of the principal amount. However, the structure of this investment is favourable when compared with a financial instrument that comes with a fixed tenure.
- Investors have the liberty to take out their money any time they want. It can be as soon as withdrawing the next day itself.
- In the case of certain investments, tax is deducted, i.e., TDS is applicable during redemption. But with liquid funds, there is no TDS redemption.
How to Invest in Liquid Funds?
Now that we know what is liquid funds, it is time to understand how to invest in them. Mutual funds with strong liquidity and little interest rate risk can benefit investors. It is regarded as one of the greatest parking options for both businesses and people. Liquid funds can be thought of as a good substitute for fixed deposits when all these factors are taken into account. Most schemes offer a redemption method in which money is returned to the bank account in just one day. By reaching out to broker via the website of a fund company, investors can quickly put their money into liquid mutual funds. It is necessary to communicate personal information, the investment amount, and the investment duration.
Investors will find that they have a variety of liquid funds to choose from. It’s important to keep in mind that there isn’t much of a difference between them in terms of performance. However, if someone wants to evaluate how liquid funds have performed, it would be best to compare their results to those of the peer group and the benchmark.
How are Liquid Mutual Funds Taxed?
Once you know what is liquid funds, it is time to understand liquid funds taxation. When talking about the meaning of a liquid mutual fund, it is important to understand how this particular fund is taxed. Like any regular mutual fund, investment done in a liquid fund comes under income tax. The implication of the tax is based on the investment’s holding period in the fund and the investment plan type, which could either be dividend or growth. If the investor chooses dividends, its taxation will depend upon the ongoing government policy for the investor.
For a growth plan, liquid funds might come under two types of taxes: long-term capital gains tax, and short-term capital gains tax.
Short-Term Capital Gains Tax
For those who want to invest in a growth plan if they liquid fund and redeem the invested amount before it completes 3 years, then they have to pay short-term capital gains (STCG) tax.
Long-Term Capital Gains Tax
Similarly, if investors want to redeem their invested money after 3 years, they must pay the long-term capital gain tax (LTCG). This will include the indexation benefits, which will be taxed at a rate of 20%. The overall nature of taxation proves that it is suitable for post-tax returns and a flexible holding period.
Did You Know?
Investing in a liquid fund is a great choice for those who have a lump sum amount of money, and intend to invest it for the long term. In addition, they want to invest periodically and systematically using a Systematic Transfer Plan (STP) into a different asset class such as equity.
Top 5 Liquid Funds in India
Here is the list of top performing mutual funds in India:
Aditya Birla Sun Life Liquid Fund Growth
Axis Liquid Fund Growth
UTI Liquid Fund – Cash Plan Growth
ICICI Prudential Liquid Fund Growth
L&T Liquid Fund Growth
What is the Tax Liability in Liquid Funds?
After answering the question – what is liquid mutual fund, it is time to look at the taxation. Tax on liquid funds is similar to those on other debt funds. The investor will have to pay short-term capital gains tax if the funds are sold before the full three years have passed. The tax rate will vary depending on which income tax bracket the person is in. Long-term capital gains tax, which is levied at 20% with indexation and 10% without it, is imposed if the funds are sold after three years.
Word to Remember
Indexation is used to accommodate the price of purchase of any investment that reflects inflation.
At this point, you should have a good understanding of what is liquid funds. People usually believe that their money is safe in the bank in their savings accounts. It gives them the liberty to withdraw their cash anytime they want to. With Liquid mutual funds, such people are provided with a more favourable and interesting option. Surplus cash, if invested in the right way, can help people garner more returns with a reasonable level of safety. After knowing what is liquid mutual funds, you can
No, there is no lock-in period, thus making it easy for you to redeem it anytime
There is an exit load, only in a situation where you redeem it in 7 days. After 7 days you do not have to pay any exit load
There is no guarantee, but the nature of this financial portfolio ensures a stable return
Yes, investors have the option to invest in Liquid Funds through SIP
Due to their short duration and reduced risk, Liquid Funds are the safest mutual fund
Yes, investing in Liquid Funds is taxable, wherein if the money is held for 3 years, it falls under long-term capital gains.
Liquid funds’ primary goal is to offer security through capital preservation. As a result, these funds invest in high rated money market securities. This is why liquid funds are thought to be more secure than any other kind of mutual funds.
Yes, you can invest a lump sum amount in liquid funds.
Liquid mutual funds offer with instant redemption facility. Within 30 minutes, you may withdraw up to Rs. 50,000, or 90% of your investment.
Here is the list of top performing mutual funds in India:
– Aditya Birla Sun Life Liquid Fund Growth
– Axis Liquid Fund Growth
– UTI Liquid Fund – Cash Plan Growth
– ICICI Prudential Liquid Fund Growth
– L&T Liquid Fund Growth
At least 20% of the assets of liquid funds must be in liquid products.
The liquid funds can go down in value. Due to the strict controls, the likelihood of them losing value is, however, not very common.