Investing in Liquid Funds: Benefits, Features, and How to Invest

What are Liquid Funds?

Liquid Funds are funds whose investment is into debt and money market securities with a maturity of up to 91 days only.

Where will your money be invested through liquid funds?

Liquid Funds primarily invest in highly liquid money market instruments and short-term debt securities, ensuring high liquidity. These include Treasury Bills (T-bills), Commercial Paper (CP), Certificates Of Deposit (CD), and TREPS with maturities up to 91 days, aiming for stable returns at low/moderate risk. 

How Do Liquid Funds Actually Work?

The primary goal of a liquid fund is to offer capital protection and liquidity to investors. To achieve this, the fund invests in debt and money market securities with a maturity of up to 91 days that are in line with the scheme's mandate.This short maturity reduces the fund's sensitivity to interest rate changes.
*Liquid funds have historically provided better returns than regular savings accounts, however these funds are subject to market risks unlike savings accounts. Further, redemption requests in these Liquid funds are generally processed within one working (T+1) day.While returns may not be the primary focus, safeguarding capital is paramount. Key aspects like maintaining a low expense ratio, ensuring high credit quality across the portfolio, and adopting a disciplined investment approach are critical components of a quality liquid fund.

How can you Invest in a Liquid Mutual Fund?

Investing in liquid funds can be done directly through the fund house or via intermediaries such as MF Central, MF Utilities and other direct Mutual Fund platforms. These platforms facilitate easy investment and tracking of your funds. 

Why Should You Invest in Liquid Funds?

Investing in liquid funds offer advantages like:
1. High Liquidity: Liquid funds provide easy access to your money, allowing you to redeem your investment quickly, usually within one business day.

2. Capital Protection: They invest in short-term debt securities, which helps in protecting your capital.

3. Better Returns than Savings Accounts: *Liquid funds may offer higher returns compared to regular savings accounts.

4. Low Risk: Due to their short maturity period (usually less than 91 days), liquid funds are less sensitive to interest rate changes and market fluctuations.

5. Convenient Parking for Surplus Funds: They are an ideal option for temporarily parking surplus funds while earning returns.

6. No Lock-in Period: Unlike fixed deposits or some other investment options, liquid funds do not have a lock-in period, offering greater flexibility.

7. Tax Efficiency: Although the returns from liquid funds are taxable, they may still be more tax-efficient compared to some other short-term investment options, especially if held for a longer period.

Taxation Rules of Liquid Mutual Funds

Short-term and Long-term Capital Gains tax:
Irrespective of the holding period, if an investor sells or redeems liquid fund units, the gains are taxed as per the investors’s tax slab rate.

Tax Implications of Dividends from Liquid Funds:
Dividends are added to an investor's taxable income and taxed according to their income tax slab rate. A 10% TDS (Tax Deducted at Source) is applicable on dividend amounts exceeding Rs. 5,000 in a financial year.

What are the factors to consider before investing?

Before investing or figuring out which liquid fund is best, it is essential to consider the following factors:

• Risk and Returns: Assess the fund’s risk and return profile to ensure it aligns with your investment options and risk tolerance. Liquid funds generally present low-risk investment opportunities.
• Expense Ratio and Other Costs: Evaluate the expense ratio and any additional costs associated with the liquid schemes such as exit loads. Liquid Funds have a graded exit load of up to 6 days and no exit load from the 7th day. as these factors can influence your overall returns. 
• Credit Quality of Underlying Securities: Investigate the credit quality of the underlying securities within the fund’s portfolio. While these funds typically invest in high-quality debt instruments with low credit risk, it is essential to check their credit ratings.
• Liquidity of the Fund: Assess the liquidity of the liquid fund to ensure it can meet your redemption needs effectively. 
• Investment Horizon: Liquid funds are categorized under debt mutual funds and having investment horizon of security which have maturity of ninety-one days. Because they have such a short investment horizon, liquid funds might be a good investment option for someone who wishes to invest in funds that come with a short maturity period.

Conclusion

In conclusion, Liquid Funds provide a highly liquid and safe investment option by focusing on short-term debt and money market instruments. *They may offer superior post-tax returns compared to traditional savings bank accounts and are ideal for parking surplus cash for short periods, typically ranging from one day to three months. Liquid Funds serve as an effective short-term investment vehicle, especially for those awaiting other investment opportunities in equities or long-term fixed income instruments. 

* Past performance is not indicative of future results. Before making any investment decisions, investors should conduct their own research and seek advice from qualified financial advisors to ensure that the respective products and strategies are suitable for their specific financial situation and objectives.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully

Please note that this article or document has been prepared on the basis of internal data/ publicly available information and other sources believed to be reliable. The information contained in this article or document is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party in any manner. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article or document.