What are Liquid Funds? Is Investing in Them a Wise Choice?

Liquid mutual funds are a kind of debt fund. For an investment horizon to be classified by duration, you must clearly understand this. The debt funds have been divided into 16 categories, ranging between Overnight and Long Duration Funds of 7 years. The SEBI initiative is to help investors find the type of fund that best fits their needs without overwhelming them with choices. 

Let’s look at liquid mutual funds and tell you everything you need to know about them before investing.

Liquid Funds Meaning

Liquid funds are debt funds that invest in short-term instruments such as Treasury bills, government securities, repurchase agreements, certificates of deposit, or commercial paper. According to SEBI rules, liquid funds are only allowed to invest in debt and money market securities with a maturity of up to 91 days. The return of the liquid fund depends on the market value of the securities it holds. However, the return of liquid funds is relatively stable compared with other debt funds, as long-term bond prices differ greatly from short-term bonds.

Features Of Liquid Mutual Funds

The features of liquid funds are explained below;

• A short liquid fund is an effective financial instrument to invest or park money needed in a few weeks or months. A liquid any other investment in a mutual fund, liquid funds are not guaranteed any return or principal. However, being very structured makes them a good option for investing money even during short-term periods rather than maintaining capital in an interest-earning fixed-tenure financial instrument.

• In the case of investments lasting more than one week, an exit load or fee to be charged for early withdrawal is often not applicable. As a result, the investment costs normally associated with mutual fund investments are reduced.

• At any time, you may withdraw your money from the fund, and even within one single day of investing, investors can receive accruals to cover each day’s investment. 

• There is no tax deduction on liquid funds redemption, unlike some instruments with deductibility at the source or the TDS applicable when redeemed.

What Is Liquid Mutual Fund Working Procedure?

The purpose of liquid funds is to provide investors with capital protection and liquidity. Therefore, according to the scheme’s mandate, the fund manager selects and invests in high-quality debt securities. In addition, It ensures that the average maturity of the portfolio is less than 91 days. The longer the maturity of the fund, the less likely it is to change interest rates. The fund manager seeks to achieve a better return when it matches the maturity of each security with that of the portfolio. There is no doubt that liquid funds offer superior returns compared to standard savings accounts.

Factors To Consider Before Investing Liquid Mutual Funds

Before investing in liquid funds in India, take a look at the following important aspects:

1. Investment Plan: 

Many investors use liquidity funds to set up an emergency fund. They offer a reasonable return at lower risk and are as stable as deposits in savings accounts. These funds aim to attract investors with a three-month investment horizon. Therefore, ensure an investment plan is developed while investing in these funds.

2. Risks: 

The liquid fund’s underlying assets don’t have a lot of volatility because their maturities range from 91 days to 91 days. Therefore, the NAV of the fund continues to be almost constant. As a result, liquid funds are low-risk investments. It is, therefore, important to note that the NAV can also be affected by a reduction in the credit rating of any existing security. The liquidity fund is not risk-free.

3. Expense ratio: 

Liquid funds also charge an annual fee for fund management services, in line with all other mutual fund schemes. This is known as the expense ratio, a percentage of total assets in the fund. Most debt investors prefer funds with a lower cost ratio since it helps them maximise their profits. In addition, most liquid fund managers invest and hold the security until maturity. Therefore, excessive buying and selling of securities does not result in any expenses incurred by the Fund, which keeps the expense ratio low.

4. Returns: 

A brief glimpse at the performance of liquid funds will show you that, on average, these products offer 7-9% returns. They are, therefore, superior to the savings account deposit rate of 4%.

Benefits Of Liquid Mutual Funds

The advantages of liquid funds are mentioned below;

1. Flexibility in the holding period: 

A liquid fund investor may be able to keep their investment in the fund for as long as is necessary. Liquid funds have unrestricted holding periods, even though a small exit load is applied for redemptions made within seven days. This enables simple entry and exit from an investment while offering secure, market-linked returns in the form of dividends over time.

2. Low risk: 

A low-risk debt fund focuses on providing the security of principal and stable returns and is a liquid fund. Therefore, the liquidity fund’s value on the market is relatively stable in each interest rate cycle. On the other hand, funds that hold longer maturity securities can vary in their ability to make strong capital gains when interest rates fall or to make heavy capital losses when interest rates rise.

3. Quick redemption: 

Redemption requests shall be processed within one working day; some funds even offer an instant redemption facility. This is possible since liquid funds invest in high-liquidity securities with a low probability of default.

4. Low cost: 

Due to the fact that they are less actively managed than other debt funds, liquid funds have minimal costs. Most liquid funds operate at a lower expenditure ratio than 1%. They can gain the highest possible returns for investors through this low-cost structure.

Who Should Invest In Liquid Mutual Funds?

Suppose you have a sizable quantity of cash not already invested and would like to take advantage of a lower-risk investment opportunity with a shorter duration. In that case, liquid funds are a great option. Your money can generate higher returns with the same liquidity than sitting in a savings account. Investors frequently employ liquid funds to start their stock fund investments. They first invest in a liquid fund before setting up the systematic transfer plan to an equity fund. This will allow them to invest in equity funds gradually and benefit from Rupee depreciation.

Conclusion

Liquid funds typically have a lower volatility of unit values than other debt funds due to their investment in shorter time, quality, and illiquid securities; therefore, it is likely that the value of their units will remain relatively stable. Interest income is the primary source of fund returns; capital gains account for only a small proportion of the total return. Liquid funds are liquid, low-cost, low-risk assets with flexible investment options. Liquidity funds aim to provide security of principal and liquidity and a modest return. 

Frequently Asked Questions (FAQs)