Importance of Liquid Funds

Are you worried about the impact of declining interest rates on your savings account and fixed deposits? If you are looking for an option where you can park your money at minimal risk and get higher returns than FDs, liquid fund is one such option. 

If you haven’t invested in mutual funds yet, you can start your mutual fund investment journey by parking your extra funds in a liquid fund.

What are liquid funds?

Liquid Fund is a category of debt fund that invests in debt papers that mature within 91 days. As the maturity period of these papers is very low, liquid fund carries lower risk than other debt funds. 

Liquid Fund is an option to park money for later use or emergencies. We can consider it as a substitute for savings account.

How do liquid mutual funds work?

The key objectives of this fund are to provide a safe and liquid place to park funds and earn higher returns than savings accounts. To do that, these funds invest in short-term papers that mature within 91 days.

Currently, the average residual maturity of the fund is around 40 to 50 days as fund managers want to make these funds as less volatile as possible. Going forward, the average residual maturity can go down further to 35 days. Residual maturity is the time or number of days till the expiration or the repayment of the invested instrument.

Liquid funds invest money market instruments, treasury bills, commercial papers etc.As the duration of the underlying securities is low, changes in the RBI’s repo rate (interest rate) do not have a significant impact on the returns.

Although liquid funds are relatively safer than other funds, it does not provide a fixed interest rate like a savings account or fixed deposit.

Benefits of Liquid Funds

Instant redemption facility:

Most fund houses offer instant redemption facility to their investors. According to SEBI guidelines, investors can redeem up to 90% of your investment value or Rs.50,000, whichever is lower. Fund houses credit the redeemed amount to your savings account within 30 minutes.

No lock-in period:

Liquid fund don’t have a lock-in period like fixed deposit. So, you can redeem from your liquid fund any time you want without worrying about paying penalty. If you haven’t availed instant redemption, fund houses process liquid fund redemption requests within 24 hours on a working day. 

Exit Load:

In the last few months, as per the directive of the market regulator, fund houses have introduced exit loads on redemption within 6 days from investment. The exit load ranges between 0.0070% and 0.0045%. However, there is no exit load, if you stay put for over 6 days.

Avail STP facility:

Investing in equity fund for long-term goals is a good option. However, if you have a large corpus and don’t want to invest it in one go, STP is the answer. Systematic Transfer Plan or STP is the facility through which you can transfer a sum of money from one mutual fund to another. As liquid funds are the least volatile, it is an excellent source mutual fund from where you can transfer a certain amount of money to an equity fund.

Park money for emergencies:

Liquid fund is a mutual fund where you can save money for future use and emergencies. In this respect, liquid funds act as a cushion from unexpected setbacks. Ideally, everyone should save at least 3 months to 6 months of expenses in a liquid fund for emergencies such as job loss or accidents.

Avoid bad debt:

You can also save money in a liquid fund to fund any big ticket purchase or vacations, instead of taking personal loan or using your credit card. Banks charge high interest along with other charges on personal loans and credit card loans. Hence, if you are not careful, it is easy to fall into the debt trap and damage your credit score.

Taxation of liquid funds

If you redeem liquid fund units within three years, the capital gains are added to your income. It is then taxed as per the applicable slab rate. However, if you withdraw after 3 years, indexation benefit is provided and the applicable gains are taxed at 20%.

Conclusion

Liquid funds are a good option to park your funds for emergencies and other short-term needs. These funds can be an alternative to savings accounts or fixed deposits as they give higher returns than bank deposit.

To select the best liquid funds for your needs, consult your financial advisor or mutual fund distributor.