Are you a beginner looking for a low-risk investment option with higher returns than a savings account? Look no further than liquid funds! Liquid funds are an excellent investment option for those seeking safety, liquidity, and reasonable returns. In this beginner’s guide, we will cover everything you need to know about liquid funds, from what they are and how they work to their benefits and drawbacks, to help you make informed investment decisions.
What Are Liquid Funds?
Liquid funds are mutual funds that invest in short-term, low-risk money market instruments such as treasury bills, commercial papers, and certificates of deposit. These funds are primarily used for parking surplus funds for short periods of time.
Liquid funds are designed to offer high liquidity and low risk. These funds generally have a low maturity period, which means the money invested can be easily withdrawn when needed. The net asset value (NAV) of liquid funds is relatively stable, which means that the value of the investment does not fluctuate much.
Liquid funds are a good option for those looking to invest surplus funds for a short period of time. They offer higher returns than a savings account and are considered low risk. They are also very liquid, which means that the money invested can be easily withdrawn when needed. Additionally, liquid funds can be used as an alternative to a savings account for emergency funds, as they offer better returns with similar liquidity.
Characteristics of Liquid Funds
Investment period
Liquid funds are short-term investments with a typical investment period of up to 91 days. This means that the investor can redeem their investment in the fund within this period. If the investor does not redeem the investment within this time period, the fund can be automatically rolled over for another period of up to 91 days.
Liquidity
Liquid funds are highly liquid, meaning that the investor can easily redeem their investment and receive the money within a short time period of 1-2 working days. This makes them a popular choice for investors who need access to their funds quickly.
Risk
Liquid funds are considered to be low-risk investments as they invest in debt instruments like commercial papers, treasury bills, and certificates of deposit issued by companies or banks. The returns on these investments are relatively stable and predictable, but there is still a chance of default by the issuer.
Returns
The returns on liquid funds are typically higher than a savings account but lower than other mutual funds. However, they are considered to be a relatively safe investment option due to the low risk involved. The returns are usually in the range of 3-6% per annum.
Types of Liquid Funds
Retail Liquid Funds
Retail liquid funds are mutual funds that invest in low-risk money market instruments, such as treasury bills, commercial papers, and certificates of deposit. They are suitable for retail investors who want to park their idle cash for a short period of time and earn better returns than a savings account.
Institutional Liquid Funds
Institutional liquid funds are mutual funds that are designed for large institutional investors, such as banks, corporations, and high-net-worth individuals. They have higher minimum investment amounts and lower expense ratios than retail liquid funds.
Direct Liquid Funds
Direct liquid funds are mutual funds in which investors can directly invest without the involvement of a broker or distributor. They have lower expense ratios than regular liquid funds, which makes them more cost-effective for investors. However, direct liquid funds are not as widely available as regular liquid funds.
Advantages of Investing in Liquid Funds
Low risk
Liquid funds are low-risk investment options that primarily invest in debt securities with a short maturity period, reducing the risk of market volatility. Hence, liquid funds are considered safer than equity mutual funds.
High liquidity
Liquid funds are highly liquid, meaning that investors can easily redeem their investments within 24 hours, making it a perfect choice for those who need their funds in the short term.
Better returns than savings accounts
Liquid funds offer better returns compared to savings accounts and fixed deposits while being as secure as a savings account. They generate returns by investing in debt securities, which have relatively stable interest rates.
Tax benefits
The returns earned from investing in liquid funds are taxable. However, investing in liquid funds for more than three years provides tax benefits under long-term capital gains. The returns earned in this period are taxed at 20% with indexation, which reduces the tax liability.
How to Invest in Liquid Funds
Choosing the right liquid fund
When you want to invest in liquid funds, you first have to select the right fund that meets your financial goals and risk appetite. You can choose a liquid fund that has a good track record and is managed by a reputed fund manager.
Investing through an AMC or online platform
Once you have chosen the liquid fund, you can invest in it through the AMC’s website or an online platform. You need to create an account, provide your personal details, and complete the KYC formalities. You can then select the fund and the investment amount you want to invest.
Minimum investment amount
Each liquid fund has its own minimum investment amount, which can range from Rs. 500 to Rs. 10,000. You need to ensure that you meet the minimum investment amount criteria to invest in the fund.
Redemption process
If you want to redeem your investment, you can do so by submitting a request through the online platform or AMC’s website. The money will be credited to your bank account within one or two business days. However, you need to keep in mind that some liquid funds may have a lock-in period, so you cannot redeem your investment before that period ends.
Liquid Funds vs. Other Investment Options
Savings accounts
A savings account is a type of bank account that allows you to deposit and withdraw money. The interest rates on savings accounts are usually very low and may not keep up with inflation, resulting in a loss of purchasing power over time.
Liquid funds, on the other hand, have higher returns than savings accounts and are still low-risk investments.
Fixed deposits
A fixed deposit is a type of investment where you deposit a lump sum of money with a bank for a fixed period of time. The interest rates on fixed deposits are usually higher than savings accounts but lower than liquid funds.
Fixed deposits have a fixed investment period and penalties for early withdrawals, while liquid funds can be redeemed at any time without penalties.
Money market funds
Money market funds are mutual funds that invest in low-risk debt securities such as Treasury bills and commercial paper. They provide higher returns than savings accounts but lower returns than liquid funds.
Money market funds have a low risk but may not be as liquid as liquid funds, as they may have restrictions on redemption.
Risks Associated with Liquid Funds
Interest rate risk
Liquid funds invest in debt securities, and their returns are impacted by the interest rates prevailing in the market. If interest rates rise, the returns of liquid funds may reduce. This risk is called interest rate risk.
Credit risk
Liquid funds invest in debt securities issued by various companies and institutions. There is a risk that these institutions may default on their payments, leading to a loss for the investor. This risk is called credit risk.
Liquidity risk
Although liquid funds are considered to be highly liquid, there may be situations when the fund manager may not be able to sell the underlying securities quickly enough to meet the redemption demand. This risk is called liquidity risk.
Conclusion
In conclusion, liquid funds offer a low-risk investment option with high liquidity and potentially better returns than savings accounts. They are available in various types and can be easily invested through an AMC or online platform. However, they are not entirely risk-free, and investors must be aware of the associated risks, such as interest rate risk, credit risk, and liquidity risk. It’s always important to do proper research and consult with a financial advisor before investing in any financial instrument.
FAQs
1. What is the minimum investment amount for liquid funds?
Most liquid funds have a minimum investment amount of Rs. 100 or Rs. 500. However, some funds may have a higher minimum investment requirement. It’s important to check with the fund house before investing to know the minimum amount required.
2. Are liquid funds taxable?
Yes, liquid funds are taxable as per the income tax laws in India. The gains made on liquid funds are added to your income and taxed as per your income tax slab. However, if you hold your investments for more than three years, you will be eligible for indexation benefits which can help reduce your tax liability.
3. How do liquid funds provide high liquidity?
Liquid funds invest in highly liquid debt instruments such as treasury bills, certificates of deposit, and commercial papers that have a short maturity period. These investments can be easily bought and sold in the market, providing high liquidity to the fund. This means that investors can easily redeem their investments without facing any significant liquidity issues.
4. How often can I redeem my investment in a liquid fund?
Most liquid funds allow investors to redeem their investments on any business day without any exit load. This means that you can withdraw your investment at your convenience. However, some funds may have a lock-in period of up to 7 days before you can redeem your investment. It’s important to check with the fund house before investing to know the redemption rules.
