Summary:
Liquid mutual funds, also known as liquid funds, are a mutual fund investment scheme where investments are made for the short run because they can be easily redeemed. This blog has all the details on how surplus funds can be parked in liquid funds.
Introduction to liquid funds
Liquid mutual funds, also known as liquid funds, are mutual fund investment schemes where the investments are in short-run, high-quality and limited-risk debt securities such as certificates of deposits, commercial papers and treasury bills. The funds are designed and structured in such a way that traders are provided safe and accessible avenues to park their extra money while being able to earn reasonable returns. The following are some of the features of liquid funds:
- Liquidity: As the name suggests, liquid funds are very liquid, implying that they can be easily bought and sold at any time and usually do not entail any exit load. Even if they do, they are minimal. The process to redeem them is easy and swift and the funds are popular because of the low lock-in period.
- Safety: Usually, liquid funds invest the money in debt instruments that have short maturity periods. The focus is usually on securities that have high credit ratings and are relatively safe. However, there are risks, even though they are minimal.
- Low volatility: The biggest advantage of liquid funds is that they are stable and experience few price fluctuations in comparison to other types of mutual funds, such as debt funds and equity that have longer maturities.
- Returns: Even though liquid funds try to provide better returns in comparison to traditional savings and fixed deposit deposits, the returns they provide are often lower than other types of mutual funds that have longer investment horizons.
- Investment horizon: These funds are best suited for investors who have short-term investment horizons and are looking to park their cash temporarily, while at the same time ensuring they have easy access to the funds should they choose to get them.
- Tax efficiency: Earnings from liquid funds are subject to capital gains tax. This is usually less than income tax rates. If the funds are held for three years or more, the earnings are then considered to be long-term capital gains and are entitled to indexation benefits.
- No entry or exit Load: Most liquid funds do not entail entry loads, and in the event there is an exit load, it is usually very low and inapplicable for short holding periods.
Liquid funds for parking surplus funds:
Liquid funds are a relatively low-risk and convenient option for investing extra cash, especially when it is anticipated that those funds may be needed in the near future. These are a preferred choice for investing extra funds for the following reasons:
- Liquidity: As suggested by the name, these funds are highly liquid investments. They can be bought and sold on any business day. Redeeming them is usually a swift process. This is what makes them a great option for investing extra funds while having easy access to it. If there is a sudden need for cash, the investment can be redeemed, and the money is typically made available within one to three business days.
- Low risk: Liquid funds mainly invest in short-term debt instruments where the goal is high credit quality and low default risk. Investments are relatively safe and are usually a risk-free investment, much less volatile than other investment options.
- Competitive returns: Even though these funds try to provide returns that are better than traditional fixed deposits, savings accounts and money market accounts. The interest rates are higher than these alternatives and make them a better option for generating extra earnings on idle money.
- No lock-in period: These funds usually do not have any lock-in period. If there is one, it's typically very short. This implies that investors can invest their extra money without having to worry about tying them up for extended periods. They can be withdrawn if and when needed.
- Diversification: Usually, liquid funds pool money from many investors and put them in diversified portfolios of short-run debt securities. This diversification helps to spread risk and minimize the impact of defaults by individual issuers.
- Tax efficiency: Earnings from liquid funds are subject to capital gains tax. Often, this is more efficient than traditional income tax rates. If the investment is held for three or more years, long-term capital gains benefits can be opted for through indexation.
- No entry or exit load: Investors prefer liquid funds because they do not charge an entry load. If there is an exit load, it is usually very low and is often not applicable after a short holding period. This means investors get to park their extra without incurring unnecessary costs.
Summing up
Even though liquid funds are low risk in comparison to other types of investments, they are not fully risk-free. There are slight risks associated with changes in interest rates and with regard to credit and liquidity in the event of massive market disruptions. It is imperative to review and analyse the fund's portfolio and the securities' credit quality before parking money in a liquid fund. With help from the right brokers/platforms, this ensures that it aligns with the financial goals and risk tolerance and that returns are maximised.