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What is liquid fund?
Liquid fund schemes are a type of mutual funds that are open-ended debt mutual fund. These mutual funds invest in very short-term marketable instruments that have a residual maturity of up to 91 days. Liquid funds invest in highly liquid money market instruments and debt securities such as Collateralized Borrowing and Lending Obligations (CBLO), Commercial Paper (CP), Treasury Bill (T-bill), government securities, call money, Certificate of Deposit (CD), etc.
Who should consider investing in liquid funds?
Liquid funds are ideal investment options for those investors who have idle, surplus cash and are looking for short-term investments. Excess funds might include bonus, other relevant gains by selling a capital asset, performance-based incentives, etc. Individuals looking to park their extra cash in short-term investment haven for a short-term goal such as planning a wedding or vacation, or paying for tuition fees, etc.
Several equity investors also use liquid mutual funds to stagger their investments into equity funds using the Systematic Transfer Plan (STP). This method is believed to yield higher returns and helpful in beating volatility over time. This is less risky than making a lumpsum investment and works similar to a Systematic Investment Plan (SIP).
Why are liquid funds so popular?
As liquid funds do not invest in volatile markets like long-term debt instrumnts or stocks, they are perceived to be as one of the least risky mutual fund asset class. Although they do not offer substantially high returns like large-cap equity schemes, they are still popular among investors. Let’s understand why:
- Low-risk
Since liquid funds invest in ultra short-term money markets that mature in 91 days, the risk due to change in interest rates further decreases. Also, unlike other mutual fund investments, liquid mutual funds do not experience excess fluctuations in the Net Asset Value (NAV) of the schemes, which further mitigates the risk. However, one should note that liquid funds are not entirely risk-free investments. - Liquidity
Liquid fund schemes are effortless and quick to access when redemption of a fund is considered. At times, when you are in dire need of cash, liquid funds can come to your rescue. The money is added to your account within a day after filing the redemption request. - Portfolio maturity
With liquid fund schemes, the maturity of the portfolio is harmonized with the maturity of the underlying debt instruments. This helps to boost returns. - No entry or exit load
In order to make liquid funds more accessible to investors, liquid funds do not charge any entry or exit loads. An exit load is a charge paid by the investor on early redemption of the fund before the due period.
How do liquid fund schemes score on the tax front?
If you hold liquid mutual funds for more than 3 years, you are mandated to pay long-term capital gains tax (LTCG) with the benefit of indexation. If you hold it for less than 3 years, you pay tax as per your tax slab. For dividend plans, the fund will be subject to a dividend distribution tax (DDT) of 12.9%.
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