Liquid Funds: A Smart Investment Move?

Liquid funds are a type of debt mutual fund that invests in short-term debt securities and money market instruments. They are considered low-risk investments with high liquidity, making them ideal for investors seeking stable options with good returns. These funds typically invest in fixed-income instruments like treasury bills, commercial papers, and certificates of deposit, with maturities of up to 91 days. The primary benefit of liquid funds is their liquidity, allowing investors easy access to their money. They are suitable for investors with a short investment horizon, those seeking higher returns than traditional savings accounts, and those looking to build emergency funds. While liquid funds offer multiple advantages, it's important to remember that they are not entirely risk-free, and investors should carefully consider their financial goals and risk tolerance before investing.

Liquid funds are a type of debt fund with a short maturity period

Liquid funds are not market-linked, which means their value does not fluctuate much, and they offer high liquidity. They are ideal for investors who want to park their surplus money for a short duration, usually up to three months, and are not suitable for long-term wealth creation.

Liquid funds are also suitable for investors who want to keep a contingency fund that can be easily redeemed in case of emergencies. They offer flexible holding periods, and investors can withdraw their money within a day, with some funds even offering instant redemption.

While liquid funds are considered low-risk, they are not entirely risk-free. They are subject to credit risk, as seen in the case of the Taurus Liquid Fund AMC crash in 2017. Additionally, investors should be aware that liquid funds are not suitable for emergency withdrawals as it takes at least one day to receive the redeemed amount.

Liquid funds are taxed as per the norms of debt funds. Returns are considered short-term capital gains if held for less than three years and long-term capital gains if held for more than three years.

They are considered one of the safest types of mutual funds

Liquid funds are considered one of the safest types of mutual funds. They are a type of debt fund that primarily invests in short-term debt securities, offering fixed returns. These funds are not market-linked and have a short maturity period, usually up to 91 days, making them less prone to changes in interest rates. The short maturity period also means that the Net Asset Value (NAV) of the fund units does not fluctuate much.

Liquid funds are known for their high liquidity, which means that investors can easily access their money when needed. They also carry a low-interest rate risk due to their short maturities. These funds are ideal for investors seeking stable investment options with good returns and are particularly suitable for those with a short investment horizon.

Liquid funds are also a good option for investors who want to keep contingency funds as they provide liquidity and safety while generating returns that are typically higher than those of traditional savings accounts. Additionally, liquid funds do not have a lock-in period, allowing investors to redeem their investments whenever they want.

While liquid funds are considered low-risk, it is important to note that they are not entirely risk-free. They are subject to credit risk, interest rate risk, and liquidity risk, although these risks are generally lower compared to other types of funds.

Liquid funds are taxed as per the norms of debt funds

Liquid funds are a type of debt mutual fund that invests in short-term debt securities and money market instruments. They are taxed as per the norms of debt funds, with returns classified as either short-term or long-term gains depending on the holding period.

Short-term Capital Gains (STCG)

If an investor sells or redeems liquid fund units within 3 years of purchase, any gains made are considered STCG. STCG is added to the investor's total income and taxed according to their income tax slab rate. This means that the tax rate will depend on the total income earned in a financial year. For example, if an investor falls under the 30% tax bracket and earns a short-term capital gain of Rs. 10,000, they will pay Rs. 3,000 (10,000 * 30%) in tax.

Long-term Capital Gains (LTCG)

If an investor holds liquid fund units for more than 3 years, the gains are categorised as LTCG. LTCG from liquid funds is taxed at a flat rate of 20%. For investments made before April 1, 2023, LTCG benefited from indexation, which adjusts the purchase price for inflation before calculating the capital gain, potentially lowering the tax burden.

Dividend Taxation

Dividends received on liquid funds are taxed at the income tax slab rate applicable to the assessee. Tax deducted at source (TDS) of 10% is applicable on dividends received in excess of Rs. 5,000.

Liquid funds are an excellent choice for investors seeking stable investment options with good returns and high liquidity. They are considered one of the safest funds among mutual fund categories due to their low-interest rate risk and short maturity period.

Liquid funds are not ideal for investors aiming for wealth creation

Low Returns

Liquid funds are debt funds that invest in short-term, fixed-income instruments such as treasury bills, commercial paper, and certificates of deposit. These funds offer stable and consistent returns, but the returns are typically lower than those of equity funds. If you are looking for high returns and significant wealth creation, liquid funds may not be the best option.

Short-Term Investments

Liquid funds are designed for short-term financial goals. With a maturity period of up to 91 days, liquid funds are suitable for investors seeking short-term solutions for their idle cash. If your investment horizon is long-term, liquid funds may not be the ideal choice.

Low-Risk Profile

Liquid funds are considered low-risk investments due to their short maturity periods and high credit-rated securities. While this makes them a safe option, it also means that the potential for high returns is limited. Investors seeking wealth creation usually aim for investments with higher risk and higher reward potential.

Emergency Funds

Liquid funds are often recommended for building emergency funds. Their high liquidity, low risk, and stable returns make them a reliable option for quick access to funds in case of unexpected financial needs. However, if your goal is wealth creation, you may want to consider investments with higher return potential.

Diversification

While liquid funds can be a valuable addition to an investment portfolio to balance the risk of equity funds, they may not be the primary driver of wealth creation. Diversifying your portfolio with a mix of short-term and long-term investments is essential, but for wealth creation, you may need to allocate more funds to growth-oriented investments.

In conclusion, while liquid funds offer multiple benefits such as high liquidity, low risk, and stable returns, they may not be the ideal choice for investors primarily focused on wealth creation. It is important to align your investment choices with your financial goals and conduct thorough research before making any decisions.

Liquid funds are a good option for investors who want to keep contingency funds

Liquid funds are ideal for investors who want to keep an emergency fund or contingency corpus because they offer high liquidity. This means that investors can easily access their money when needed, usually within one working day, and sometimes even instantly. There is no lock-in period for liquid funds, so investors can redeem their investment at any time without penalty after seven days of investment.

In addition to their liquidity, liquid funds also offer stable returns that are typically higher than those of traditional savings accounts or fixed deposits. This makes them a good option for investors who want to earn a return on their contingency funds while keeping them safe and easily accessible.

Liquid funds are also suitable for investors who want to keep their funds liquid and easily transferable to other long-term investments. They are a good option for those who are risk-averse and prefer stable, consistent returns over the potential for higher returns with greater risk.

Overall, liquid funds are a good option for investors who want to keep contingency funds because they offer high liquidity, stable returns, and the ability to easily transfer funds to other investments.

Frequently asked questions