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Are you planning to invest your hard-earned money for just a short time and get better returns than your savings account? Or are you looking for a potentially low risk investment that can be easily withdrawn in an emergency? If you answer “Yes” to above questions, liquid funds, a type of debt fund, might be a good fit for you. Read on to know what is a liquid fund, their benefits, limitations, and much more.
What Are Liquid Funds?
Liquid funds are a type of debt mutual fund that invests in debt securities with residual maturity of 90 days or less. This type of mutual fund primarily investments of this scheme are debt and money market instruments, which include corporate and government bonds, debentures, Certificates of Deposit (CD), Commercial Papers (CP), Treasury Bills (T-Bills), etc.
A majority of these fixed-income securities are held till maturity, that combined with the short maturity of underlying investments makes liquid funds a potentially low volatility investment. As a result, liquid funds are considered ideally suited as a short term investment options by even conservative investors. However, returns from these mutual fund schemes is not guaranteed and dependent on performance of the investments debt/money markets.
How do Liquid Mutual Funds Work?
Before getting into the benefits and limitations, let us understand a bit more about the meaning of liquid funds. The main aim of a liquid fund is to offer a high degree of liquidity and capital safety to the investor making it an ideal short term investment option. To meet these objectives, the fund manager invests your amount into high quality debt instruments with an average maturity period of up to 90 days.
The short maturity of these investments helps reduce the interest-rate sensitivity of liquid funds and reduces the potential volatility of the investment. As a result, the fund value of liquid mutual funds does not experience a lot of fluctuations, making it a relatively low-risk market-linked investment option. Thus these mutual fund schemes are undoubtedly an excellent option for you to park your idle money while offering returns that are at par with or higher than fixed deposits of comparable tenure.
Who Should Invest in Gilt Funds
Gilt funds are considered suitable for those that prioritize security above high returns and are seeking to stay invested for longer periods usually 3 years or longer. Historically, over the medium to long term, gilt funds have provided a good balance between capital preservation and reasonable returns. In addition, it offers superior asset quality of the underlying investment in comparison to equity funds and even many debt funds. These work well when markets are plummeting. High gains are provided by interest rate volatility, but the fund is also subject to interest rate risk.
Features & Benefits of Investing in Liquid Funds
After understanding what are liquid funds, it is time to look at their key features and benefits. Knowing these details of liquid mutual funds can help investors make an educated decision regarding whether these schemes are a suitable investment for them:
- Market Linked Returns
Liquid funds offer market-linked returns so returns from these schemes is not guaranteed. However, historically these debt schemes have offered comparatively higher return to investors in comparison to what bank deposits offer.
- Low Volatility and Risk
As discussed earlier liquid funds are mainly invested in debt instruments with residual maturity of 90 days or less. More over these funds are primarily invested in high quality AAA and A1+ rated instruments that feature relatively low investment risk.
- High Liquidity
Liquidity refers to the ease with which an asset can be converted into cash. The redemption from these funds are typically credited to the investor’s bank account in 1 day. Moreover, there is no lock-in period with liquid mutual funds.
- No Exit Load
The liquid funds usually have no exit load as long as units have been held more than 7 days. Therefore, with these funds, you can instantly redeem cash after 7 days without any penalty for premature withdrawal unlike fixed deposits or recurring deposits. This makes liquid funds an ideal option for maintaining emergency funds that can be easily withdrawn as and when required.
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- Minimum Investment
Liquid funds are undoubtedly better than bank fixed deposits as these funds are quite affordable. With only INR 500, you can invest in liquid mutual funds via a systematic investment plan (SIP). Also, the lump sum investing starts at INR 1,000 only. So, these funds are best for all those who are searching for an affordable investment option.
- Flexibility
The liquid funds are offer with both growth and IDCW (Income Distribution cum Capital Withdrawal) options. So, the ones who are looking for capital appreciation can opt for the growth option, while those who are looking for dividend payouts can opt for the IDCW option.
- Suitable for Conservative Investors
Liquid funds with their low volatility are suitable for even conservative investors who want their investment principal to be at the lowest possible level of risk.
Limitations of Investing in Liquid Funds
Now that we know what is liquid mutual funds and their key features and benefits, let us take a look at their limitations:
- No Guarantee of Returns
Since performance of liquid funds are linked to the market, therefore, they also experience constant fluctuations. Thus, there is no guarantee of returns or safety of the principal amount invested in the scheme.
- Management Fees
In the case of liquid funds, a fund manager will manage your investment portfolio, and therefore, they charge a fund management fee from the investor. This will decrease the potential returns from the investment as these fees and expenses are deducted from the returns generated by the scheme.
- Taxability of Returns
Like other debt-oriented mutual funds, short term capital gains and long term capital gains taxation rules apply to investments made into liquid funds. The taxation of mutual funds in this category are also responsible for reducing the potential returns one can get from these investments.
Who Should Invest in Liquid Funds?
Liquid funds are considered a suitable investment option for those with substantial idle cash and looking for short-term investment options. Thus, liquid funds can be used for short-term parking of funds which may be later used for investment in equity via a systematic transfer plan. Also, this type of investment is also suitable for those who receive windfall gains or got a huge amount of money but have no idea where to invest their surplus funds. Additionally, the combination of low risk and high liquidity of liquid mutual funds also make them suitable for use as a way to keep your emergency funds handy.
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Frequently Asked Questions (FAQs)
Q. Are liquid funds risk-free options?
In comparison to many other types of investments, liquid funds are one of the safest investment options as these funds invest in very short maturity papers and securities with high credit ratings. This reduces the overall risk of investing in the scheme.
Q. Do liquid funds are associated with exit load?
Yes, these funds have an exit load only if you redeem them within 7 days of investing. After this period, you are not required to pay any exit load.
Q. Can we do SIP in liquid funds?
Yes, apart from lump sum investments, the option for SIP in liquid funds is available for investors. You need to decide on how frequently you want to invest, and money will get auto‐deducted from your account and invested.
Q. When can invested money be redeemed from liquid funds?
Liquid funds offer instant redemption features to investors. You can instantly withdraw an amount up to ₹50,000, and it will reach your bank account in a few minutes.
Q. Do liquid funds offer guaranteed returns to the investor?
No, the returns on investment are not guaranteed, but it offers a stable return to the investor, owing to the nature of the investor's portfolio.
Sources:
https://cleartax.in/s/liquid-funds
https://www.rankmf.com/advantages-and-disadvantages-of-liquid-funds
https://www.edelweissmf.com/investor-insights/mutual-fund-investment-tips-and-articles/all-you-need-to-know-about-liquid-mutual-funds
https://www.amfiindia.com/investor-corner/knowledge-center/liquid-funds.htm
https://www.miraeassetmf.co.in/knowledge-center/what-is-liquid-fund
ARN No : May23/Bg/08
