Liquid Fund Investment: Strategies For Success

Liquid funds are a type of investment that can be quickly and easily converted into cash. They are ideal for those looking to invest spare cash over a short period of time, usually three months or less, and are a good alternative to a savings account as they offer higher returns. Liquid funds are high-liquidity, open-ended income schemes that invest in debt and money market instruments, such as government securities, treasury bills and call money. These instruments have a maximum maturity period of 91 days and are considered safe because they mitigate interest rate volatility risk. They are also unique in that they have no lock-in period, meaning investors can withdraw their funds within 24 hours.

Liquid funds vs savings accounts

Liquid funds and savings accounts are both useful for storing money in different ways. Savings accounts are the most popular option for storing savings or extra funds, as well as emergency funds, due to their safety. However, they are not the best option from an investment perspective, as the rate of return is low.

Liquid funds, on the other hand, are a type of debt mutual fund with a short-term investment horizon. They are open-ended schemes that invest in money market instruments, such as certificates of deposit, treasury bills, and commercial papers, which mature within 91 days. They are considered low-risk because they invest in short-term assets, and they aim to preserve capital and offer liquidity.

Liquid funds can provide higher returns than savings accounts, making them a better option for surplus cash. For example, savings accounts offer interest rates of between 2.7% and 4%, or up to 6% for senior citizens, whereas liquid funds can provide returns of 6-7%. Additionally, liquid funds offer flexibility, with no lock-in period and the ability to redeem investments within 24 hours. However, it is important to note that liquid funds are not entirely risk-free, as they are subject to interest rate risk and credit risk.

When deciding between liquid funds and savings accounts, it is essential to consider your financial goals and risk tolerance. If you have a significant amount of money to deposit and are comfortable maintaining a minimum account balance, a liquid fund could be a good option for higher returns. On the other hand, if you have a smaller sum and want to avoid account minimums and fees, a savings account may be more suitable.

In summary, liquid funds offer higher returns and better liquidity than savings accounts but come with slightly higher risks. By comparing the features and considering your financial situation, you can decide which option is best for you.

Liquid funds vs fixed deposits

Liquid funds and fixed deposits are two of the most popular investment options that are considered safe. However, there are some key differences between the two.

Liquid funds are a class of debt funds that invest in short-term, fixed-income instruments such as treasury bills, commercial papers, and government bonds. These funds aim to provide safety and liquidity to investors by investing in high-quality, low-risk instruments. Liquid funds have a maturity period of up to 91 days and offer better returns than fixed deposits, though they carry a slightly higher risk due to their exposure to market volatility. They are ideal for investors with low to medium-risk tolerance and are a good option for those seeking short-term investments with stability.

On the other hand, fixed deposits are a popular form of bank deposits where individuals invest a lump sum over a fixed period, typically ranging from 7 days to 10 years. Fixed deposits offer a higher interest rate than regular savings accounts, and the interest rate is guaranteed by the Reserve Bank of India. Fixed deposits are considered extremely low-risk investments as they are offered by banks and insured up to a certain limit. They are ideal for investors with low to zero-risk tolerance and those seeking long-term investment options.

When comparing the two, liquid funds offer greater liquidity and flexibility, as they can be redeemed at any time with low penalty charges. Fixed deposits also offer liquidity, but premature withdrawals incur higher penalty charges. In terms of returns, liquid funds tend to offer better returns than fixed deposits, though they do not offer any guaranteed returns. Fixed deposits, on the other hand, offer a fixed rate of return that is typically lower than liquid funds but higher than savings accounts.

From a taxation perspective, liquid funds held for more than three years are taxed as long-term capital gains at a concessional rate, while those held for three years or less are taxed at the applicable income tax slab rate. Fixed deposits, on the other hand, are taxed at slab rates as income from other sources. Tax-saving fixed deposits offer tax deductions but come with a lock-in period.

In summary, liquid funds are ideal for investors seeking short-term investments with higher returns and greater liquidity. Fixed deposits, on the other hand, are better suited for those seeking long-term investments with guaranteed returns and a low-risk appetite.

How liquid funds perform

Liquid funds are a type of debt mutual fund that invests in short-term debt securities and money market instruments. These funds are known for their high liquidity, allowing investors easy access to their money. They are categorised based on duration, with options ranging from overnight funds to long-duration funds of up to seven years.

Liquid funds primarily invest in short-term, high-quality securities, such as government securities, treasury bills, commercial paper, and certificates of deposits. These instruments typically have maturities of up to 91 days and are considered safe due to their short maturity periods, which help mitigate interest rate volatility risk. The short maturity of the underlying instruments also enables investors to easily access their funds, making liquid funds suitable for those seeking stability and liquidity.

The primary objective of liquid funds is to preserve capital while providing reasonable returns. Fund managers continuously monitor the portfolio, making investment decisions to align with this goal. The focus on capital preservation means that liquid funds are considered low-risk investments. They maintain a relatively stable value across varying market interest rate cycles, as they are less susceptible to substantial capital gains or losses that may occur with longer-term securities.

Liquid funds offer several advantages, including high liquidity, low risk, and potential for competitive returns. They are an excellent choice for short-term investors, cash reserve holders, and those transitioning to equity funds. The flexibility of liquid funds allows investors to retain their investments for as long as needed, with the option to redeem funds within a short timeframe, typically within 24 hours.

Liquid funds taxation

Liquid funds are a type of debt mutual fund that offers easy access to your cash and predictable returns. They do so by investing in short-term debt instruments, typically with maturities of up to 91 days. These include treasury bills, government securities, and commercial paper. The returns on these funds depend on the market price of the securities they hold.

When it comes to taxation on liquid funds, it's important to understand the concept of the holding period. The holding period refers to how long you hold your investment before redeeming it, and it determines how your liquid funds are taxed. In India, there are two categories of holding periods:

• Short-Term Capital Gains (STCG): If you redeem your liquid fund units within 3 years of purchasing them, any gains made are considered STCG.
• Long-Term Capital Gains (LTCG): If you hold your liquid fund units for more than 3 years, the gains are categorised as LTCG.

Tax Implications:

For Short-Term Capital Gains (STCG), the gains are added to your total income and taxed according to your income tax slab rate. This means that the tax rate will depend on your total income for that financial year. For example, if you fall into the 30% tax bracket and earn a short-term capital gain of Rs. 10,000, you will pay Rs. 3,000 (10,000 * 0.3) as tax.

For Long-Term Capital Gains (LTCG), the rules depend on when the investments were made. For investments made on or after April 1, 2023, LTCG from liquid funds will be taxed at a flat rate of 20% without any indexation benefit. This means you will pay tax on the entire gain, which could result in a higher tax liability compared to investments made before this date.

For investments made before April 1, 2023, these investments benefit from indexation, which reduces the taxable gain and potentially lowers your tax burden. The purchase price is adjusted for inflation using a government-provided index before calculating the capital gain. Long-term capital gains are currently taxed at a rate of 20%.

Dividends received from liquid funds (mutual funds) are taxed at the income tax slab rate applicable to the individual. A Tax Deducted at Source (TDS) of 10% is applicable to dividends received that exceed Rs. 5,000.

Liquid funds are taxed under the head of income from capital gains, while dividends are taxed under the head of income from other sources. It's important to note that liquid funds do not guarantee returns, and the return will depend on market interest rates.

How to invest in liquid funds

Liquid funds are a type of investment that can be quickly and easily converted into cash. They are ideal for those looking to invest their spare cash for a short period of time, typically three months or less, and earn higher returns than they would with a regular savings account.

Liquid funds are a type of mutual fund that invests in short-term debt securities, such as government securities, treasury bills, fixed deposits, and other money market instruments. These funds have a maximum maturity period of 91 days and are considered safe because they mitigate interest rate volatility risk. The credit risk is also low, and there is no lock-in period, meaning investors can withdraw their funds within 24 hours upon request.

Liquid funds offer higher returns than traditional savings accounts, with annual returns of 7-9% compared to the near-0% interest of savings accounts. They are also more liquid, with redemption payouts credited to the investor's bank account on the next working day.

To invest in liquid funds, individuals can follow these steps:

• Sign up or log in to an investment platform or brokerage.
• Select the option for mutual funds, and then liquid funds.
• Choose the specific fund to invest in by comparing similar schemes and using tools like SIP or Lumpsum calculators to estimate the future value of the investment.
• Click on "Invest Now" and select either a lump sum or Systematic Investment Plan (SIP) investment.

It is important to note that while liquid funds offer higher returns and more liquidity than savings accounts, they also come with some risks. The returns are not guaranteed and can fluctuate. Additionally, there may be fees associated with liquid funds, such as expense ratios, which can impact the overall returns.

Liquid funds are suitable for investors who want to park their idle cash for a short period and earn higher returns. They are ideal for short-term financial goals and should not be used for long-term investment horizons.

Frequently asked questions