A Liquid Mutual Fund is a debt fund which predominantly invests in liquid money market and debt securities which are of shorter duration maturity of upto 91 days. Asset allocation in Liquid fund consists of:
Treasury Bills (T-bills),
Government Securities (G-secs),
Commercial Paper (CP),
Certificates of Deposit (CD)
Collateralized Lending & Borrowing Obligations (CBLO).
Liquid funds don’t have any lock-in period and provide low interest rate risk in the debt fund category. Some Liquid funds also provide redemption within 24 hours of the business day.
How do they work?
The primary focus of liquid funds is to provide a high degree of liquidity & safety of the capital for investors. Since liquid fund portfolio is invested in for short duration (91 days), it has low sensitivity of interest rate movements, making liquid funds less volatile and provide steady returns.
How much returns do Liquid Funds provide?
Liquid funds are a good alternative against savings account deposits and tend to provide better return than fixed deposits. Even though the returns are not guaranteed but are less risky than equity funds.
Who can invest in Liquid Fund?
Anyone who has surplus cash can park their idle money by investing in a liquid fund which lets you earn slightly higher returns and better liquidity. Liquid funds are said to be an entry point to invest in mutual funds. It also allows you to switch from liquid fund to other category of mutual funds of your choice.
Other traits of Liquid Fund
Unlike other funds, Liquid Funds generally have a lower expense ratio. They are preferred by most debt investors, as it helps in maximizing their gains. Since portfolio maturity is of a shorter period, liquid funds invest and hold the security until maturity. Thus, the fund does not incur expenses due to excessive buying and selling of securities.
Since liquid funds fall in the category of debt funds. They provide tax indexation benefit which helps long term investors to cope better with inflation when subjected to capital gains tax.
Liquid funds are used by many investors to create an emergency fund as they are highly liquid. Ideally, they are designed for investors with a 3-month investment horizon. Wealth managers suggest liquid funds as a suitable parking ground when you have a sudden influx of cash, which could be from a huge bonus, or selling of real estate property and so on and so forth. Investors looking out for opportunities in equities and long-term fixed income instruments can also park their money in the liquid funds until a favorable opportunity arises in the market.
Liquid Funds do not charge any exit loads after 7 days from the date of investment. The exit load amount gradually reduces from the first day to the 7th day from the date of investment. It offers growth & dividend options.
In dividend option, one can choose daily, weekly or monthly dividends depending on their investment horizon & principle amount. Redemption requests in these Liquid funds are processed within one working (T+1) day. Since today it’s become easier to invest in Mutual Funds, individual investors may choose Liquid funds as an effective short-term investment option over their savings bank account.