Liquid Funds India: A Smart Investment Guide

Liquid funds are a type of debt mutual fund that invests in short-term debt securities and money market instruments. They are highly liquid, meaning investors can easily access their money when needed. These funds are ideal for investors who want to invest for a very short term and are looking for an alternative to bank accounts or deposits. Liquid funds are also suitable for investors who want an alternative to bank deposits with good returns.

Liquid funds vs fixed deposits

Liquid funds and fixed deposits are two of the most popular investment options in India, both considered safe. However, there are several differences between the two that investors should be aware of before making a decision.

Liquid funds are a type of debt fund that invests in short-term, fixed-income instruments such as treasury bills, commercial papers, and corporate and government bonds. These funds have a maturity period of up to 91 days and aim to provide safety and capital preservation for investors. Liquid funds are considered relatively safer than other mutual funds and offer higher returns than regular savings accounts. They are ideal for investors who are risk-averse and looking for short-term investments.

Fixed deposits, also known as term deposits or time deposits, are offered by banks and non-banking financial companies (NBFCs). They allow individuals to deposit a lump sum over a fixed period, typically ranging from 7 days to 10 years, and earn a higher interest rate than regular savings accounts. Fixed deposits are suitable for those seeking low-risk investments and are willing to commit to a longer investment horizon.

Comparison between Liquid Funds and Fixed Deposits:

| | Liquid Funds | Fixed Deposits |

|---|---|---|

| Risk | Relatively safer than other mutual funds but carry a higher risk compared to fixed deposits | Considered one of the safest investment options |

| Returns | Offer higher returns than fixed deposits but do not provide guaranteed returns | Provide a fixed rate of return that is typically lower than liquid funds |

| Liquidity | Offer better liquidity and flexibility with low penalties for premature withdrawals | Have a lock-in period and attract penalties for premature withdrawals |

| Investment Horizon | Suitable for short-term investors | Ideal for long-term investors |

| Taxation | For investments held for more than 3 years, returns are taxed as long-term capital gains (20% after indexation). For shorter investments, returns are taxed at slab rates. | Taxed at slab rates as income from other sources. TDS may be applicable if interest income exceeds a certain threshold. Tax-saving FDs offer deductions. |

In summary, both liquid funds and fixed deposits are attractive investment options depending on an individual's risk appetite, investment horizon, and financial goals. Liquid funds offer higher returns and flexibility but are subject to market risk. On the other hand, fixed deposits provide stability and guaranteed returns but with lower returns and less flexibility.

Liquid funds for contingency funds

Liquid funds are a great option for investors who want to keep a contingency fund. They are a type of debt fund that invests in fixed-income instruments like commercial paper, government securities, treasury bills, etc. with a maturity period of up to 91 days. They are highly liquid and carry a low-interest rate and default risk.

Liquid funds are ideal for investors who want to keep an emergency or contingency corpus that is safe and can be redeemed when necessary. They are also suitable for investors who want an alternative to bank deposits as they usually offer higher returns than savings accounts and have more flexibility for withdrawals. Liquid funds are also a good option for those who want to park their money for a short period, typically ranging from one day to three months.

Liquid funds are one of the safest types of mutual funds due to their extremely short lending duration and the high quality of borrowers. They are also highly liquid and usually do not have an entrance or exit load. The expense ratio of liquid funds is also comparatively low due to their low-holding period.

Some of the top-performing liquid funds in India include:

• Mahindra Manulife Liquid Fund
• Aditya Birla Sun Life Liquid Fund
• Edelweiss Liquid Fund
• PGIM India Liquid Fund
• Bank of India Liquid Fund

Liquid funds for short-term investors

Liquid funds are a type of debt fund that invests in short-term assets like treasury bills, repurchase agreements, certificates of deposit, or commercial paper. These funds are only permitted to invest in debt and money market tools with maturities of up to 91 days under SEBI rules. They are highly liquid and carry the lowest interest-rate risk in the debt funds category. Liquid funds are best suited for those with an investment horizon of up to 3 months.

Liquid funds are suitable for investors who want to put money aside for emergencies, as they have a near-zero risk of loss if someone invests for at least one month. They are also a good option for investors who want an alternative to bank deposits, as they can offer higher returns for a shorter period of time with minimal risks. Liquid funds are also suitable for investors who need to park funds temporarily, such as when they receive a bonus or inheritance, and are undecided about where to deploy that money.

Liquid funds typically do not charge any exit loads, and investors are offered growth and dividend options. Redemption requests are usually processed within one working day. The main objective of a liquid fund is to provide capital protection and liquidity to investors. Therefore, the fund manager selects high-quality debt securities and ensures that the average maturity of the portfolio is not more than 91 days.

When investing in liquid funds, it is important to consider the risk factor, expected returns, the horizon of investment, costs associated, and financial goals. Liquid funds are associated with lower risk and provide stability across different interest rate cycles in the market. They are also low-cost options, with most liquid funds having an expense ratio below 1%.

• Mahindra Manulife Liquid Fund
• Aditya Birla Sun Life Liquid Fund
• Edelweiss Liquid Fund
• PGIM India Liquid Fund
• Bank of India Liquid Fund
• Union Liquid Fund
• Axis Liquid Direct Fund
• Nippon India Liquid Fund
• Mirae Asset Liquid Fund

Liquid funds for investors transitioning to equity funds

Liquid funds are a type of debt mutual fund that invests in short-term debt securities and money market instruments. They are highly liquid, allowing investors to easily access their money when needed. Here are some key points about liquid funds for investors transitioning to equity funds:

• Low-Interest Rate Risk: Liquid funds primarily invest in fixed-income assets with short maturities, typically up to 91 days. This makes them less prone to changes in interest rates, resulting in lower interest rate risks compared to other debt funds.
• Capital Protection and Liquidity: The main objective of liquid funds is to provide capital protection and liquidity to investors. Fund managers select high-quality debt securities with short maturities to achieve this goal.
• Flexible Holding Period: Liquid funds offer flexible holding periods, allowing investors to retain their investments for as long as needed. While there is a minor exit load for redemptions within seven days, liquid funds provide simple entry and exit options.
• High Liquidity and Low Risk: Liquid funds are highly liquid and are considered one of the safest mutual funds due to their short lending duration. They are ideal for investors seeking low-risk investment options.
• Competitive Returns: Liquid funds offer competitive returns that are typically higher than traditional savings accounts or fixed deposits. They provide stable returns, making them suitable for investors transitioning to equity funds, as they offer stability and flexibility.
• Taxation: Dividend income from liquid funds is tax-free for investors. However, capital gains are taxable. Short-term capital gains are taxed at the investor's income tax slab rate, while long-term capital gains (holding period over three years) are currently taxed at a rate of 20% after indexation.
• Ideal for Short-Term Goals: Liquid funds are ideal for investors with short-term financial goals or those looking for temporary parking funds. They provide stability and liquidity, making them a good option for investors who need quick access to their funds.

Taxation on liquid funds

Dividend Income

Dividend income from liquid funds is generally tax-free in the hands of investors. This is an advantage compared to pure debt instruments, where dividend income may be taxable. However, it is important to note that the fund itself deducts a dividend distribution tax (DDT) of 28.84% when paying out dividends.

Capital Gains

Capital gains from liquid funds are taxable, and the tax treatment depends on the holding period. If an investor redeems the units of a liquid fund at a price higher than their purchase price, resulting in a capital gain, the following tax rules apply:

• Short-Term Capital Gains: If the units are redeemed within three years of holding, the gains are considered short-term capital gains and are taxed at the investor's applicable income tax slab rate.
• Long-Term Capital Gains: If the units are redeemed after three years of holding, the gains are considered long-term capital gains. In this case, the investor benefits from indexation, which adjusts the purchase price for inflation using a government-provided index. Long-term capital gains are currently taxed at a rate of 20% after indexation.

Liquid funds are considered non-equity funds for tax purposes, and their taxation rules are similar to those of debt funds. The main objective of liquid funds is to provide liquidity and capital protection, with stable returns. Therefore, investors should consider their financial goals and return expectations when investing in liquid funds, as these funds are not designed for wealth creation.

Frequently asked questions