Liquid Fund Investment Strategies: Where To Invest?

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 to easily access their money when needed. Liquid funds invest in short-term, good-quality, and liquid securities, such as treasury bills, commercial paper, and certificates of deposit. They are designed to provide safety of principal and liquidity, as well as a modest return. The fund managers select high-quality debt securities and ensure that the average maturity of the portfolio is not more than 91 days. Liquid funds are suitable for investors with a short investment horizon, those who want to park a large corpus temporarily, or for use as a medium to route funds into other long-term funds.

Treasury Bills

T-bills are issued at a discount from their face value, with maturities ranging from four to 52 weeks. For example, if you want to buy $1,000 worth of T-bills yielding 5%, the U.S. Treasury will sell them to you at a discounted price of $950. At maturity, you will receive the full $1,000, with the additional $50 representing your earned interest.

T-bills are actively traded on the open market and can be easily bought or sold in the secondary market before maturity, making them a flexible investment option. They are also exempt from state and local income taxes, although interest income is subject to federal income tax.

Risks and Considerations

While T-bills are considered a safe investment, there are a few risks to consider:

• Opportunity Cost: T-bills offer very low returns, and there is a risk of foregoing higher returns by investing in riskier assets.
• Inflation: Rising inflation can erode the value of interest payments and even the principal's value. T-bills become less attractive to investors in highly inflationary environments.
• Interest Rates: T-bills become less attractive when interest rates rise, as investors can receive higher interest income elsewhere.
• Market Risk: In a growing economy, T-bills may become less attractive as stocks appear less risky and offer higher returns.

How to Invest in T-Bills

There are a few ways to invest in T-bills:

• TreasuryDirect: You can open an account on TreasuryDirect.gov, the federal government's platform for selling bonds. The process involves selecting an account type, providing personal information, creating a username and password, verifying your account, and placing your order.
• Brokerage Account: You can also place an order through a broker, such as Fidelity, Vanguard, or Charles Schwab. These firms typically do not charge fees for T-bill purchases.
• Secondary Market: Investors can also buy T-bills in the secondary market, although purchasing new issues through auctions is generally recommended to avoid unnecessary costs.

Commercial Paper

There are several advantages to using commercial paper as a source of funding. Commercial paper can be issued quickly, making it a good option for companies that need to raise funds on short notice. It also offers flexibility, with companies able to use commercial paper for a variety of purposes. Additionally, commercial paper tends to have lower costs than other types of short-term borrowing, and it can help companies demonstrate their financial stability and creditworthiness to potential investors.

However, there are also some risks associated with commercial paper. These include credit risk, where the issuer may default on its payment obligations; interest rate risk, where the value of commercial paper may fluctuate with changes in interest rates; liquidity risk, where commercial paper may not be easily traded or sold; and regulatory risk, where commercial paper is not subject to the same level of regulatory oversight as other types of securities.

Certificates of Deposit

A certificate of deposit (CD) is a type of savings account that offers a fixed interest rate on money held for a specified period. CDs are considered a safe and conservative investment option, but they offer lower growth opportunities than stocks and bonds. They are available at banks, credit unions, and brokerages, with terms ranging from 3 months to 10 years.

Liquid CDs, also known as no-penalty CDs, are a type of CD that allows for withdrawals without penalties before the maturity date. This flexibility makes them a good choice for those seeking a more adaptable savings option. However, liquid CDs typically offer lower interest rates than traditional CDs.

• Liquidity: Liquid CDs provide the advantage of accessing and withdrawing funds before the term ends, making them suitable for emergencies or financial goal adjustments.
• No Penalties: There are no fees for early withdrawals, allowing you to access your money without incurring additional costs.
• Security: Liquid CDs are federally insured, providing a level of protection for your investment.
• Guaranteed Returns: The interest rate is usually known upfront, offering a guaranteed return, although it may be lower than other investments.

When considering a liquid CD, it's important to review the withdrawal rules and minimum deposit requirements, as these can vary among financial institutions. Additionally, keep in mind the tax implications, as earnings on liquid CDs are taxed at the federal rate.

Alternatives to liquid CDs include traditional savings accounts, high-yield savings accounts, and money market accounts, each offering different levels of liquidity, interest rates, and flexibility.

Money Market Securities

Treasury bills are issued by governments and are considered the safest type of money market security. They are sold at a discount from their face value and are actively traded after being issued. T-bills are not only savings instruments but can also be used to settle transactions, as they can be sent through the payments system just like money.

Certificates of deposit are issued by commercial banks and can be purchased through brokerage firms. They come with a maturity date ranging from three months to five years and can be issued in any denomination. Most CDs offer a fixed maturity date and interest rate but attract a penalty for early withdrawal.

Commercial paper is an unsecured loan issued by large institutions or corporations to finance short-term cash flow needs. It is issued at a discount, and the difference between the price and face value is the profit to the investor. Only institutions with high credit ratings can issue commercial paper, so it is considered a safe investment.

Repurchase agreements are a short-term form of borrowing where a security is sold with an agreement to repurchase it at a higher price at a later date. The Federal Reserve buys repurchase agreements to regulate the money supply and bank reserves.

Government Securities

Liquid funds primarily invest in short-term, high-quality securities, such as government securities, to ensure quick redemption and minimise the risk of capital loss while offering attractive yields. Government securities are considered safe investments with low default risk, making them suitable for liquid funds' objective of capital preservation and liquidity.

Liquid funds that invest in government securities have a maturity period of up to 91 days, as per SEBI regulations. This short maturity makes these funds less prone to changes in interest rates, providing stable returns to investors. The shorter maturity also ensures that liquid funds can easily meet redemption demands, typically processing them within 24 hours.

Liquid funds that invest in government securities carry a low-interest-rate risk due to their short maturities. They are suitable for investors seeking stable investment options with good returns and high liquidity, such as those looking for short-term investments or wanting to park their funds temporarily.

Overall, government securities are an essential component of liquid funds' investment strategy, offering safety, liquidity, and competitive returns to investors.

Frequently asked questions