How to use liquid funds to boost your SIP returns from equity mutual funds and shares

Liquid funds are seen as an alternative to savings accounts for holding surplus cash for short durations. But they are not just for holding your idle cash. If used smartly, liquid funds can help in boosting your mutual fund SIP portfolio.

How can liquid funds help?

With the Systematic Investment Plan (SIP), you invest a fixed amount at a fixed duration into a mutual fund scheme or equity shares. The fixed duration is usually a month in the case of SIP.

Most of the common investors have their SIPs linked to their savings accounts.

If your SIP date is on the 5th day of a month, then the fixed amount will be automatically deducted from your savings account for investment into the selected mutual fund or equity share. While this has been a tried and tested method for SIP for years, there is a limitation to this approach in the present context.

Investors usually have more than just the SIP amount in their savings account, sometimes for days, and sometimes even for months.

However, the amount remaining in the savings account after contribution towards the SIP does not earn any significant interest. It keeps sitting idle in your account, generally depreciating in value due to inflation.

But there is a way in which even this idle amount can earn some interest and, in the long run, boost the value of your overall SIP portfolio.

The way we are talking about is setting up a Systematic Transfer Plan (STP) through liquid funds.

Unlike SIP, where money is deducted from your savings account, the STP contributes from your investment in a liquid fund. You can choose the frequency and amount to be transferred under STP. But wait, isn't it same as SIP? What's the difference? You may ask.

There is a slight difference between the two approaches. And for long-term investors, even a small difference can mean a lot of money

What difference can STP with a liquid fund make?

In SIP, your money usually has to wait in a savings account before it is deployed in a mutual fund scheme or equity shares. This money doesn't earn meaningful interest during the waiting period.

In contrast, STP through a liquid fund always makes your idle money work for you before it is deployed. It also helps in other situations such as:

• When you do not want to invest a lump sum at one go. Rather, you plan to invest gradually depending on the market situation, or

• When you want to keep some cash handy for deployment in equity mutual funds or shares when the markets become favourable.

Suppose you have ₹1 lakh and two options to deploy the amount:

1. Put the money in a savings account and do a SIP of ₹5,000/month
2. Put ₹1 lakh in a liquid fund and set up STP of ₹5,000/month

In the first option, only ₹5000 is invested per month, while the balance earns an annual interest of only around 2.5% if it is with a major bank.

In the second option, the balance amount has the chance to earn 6-7% interest. It also allows you to stagger your investments or time your entry into equity.

Limitations of STP through liquid funds

STP through liquid funds can be a smart choice over a savings account whenever you have a lump sum in hand, but you want to stagger your investment.

However, there are some limitations of STPs that you should know before getting into it:

1. You need to set up STP between two funds of the same mutual fund house. For example, you can't set up STP between HDFC Liquid Fund and DSP Midcap Fund.

2. You can get a tax exemption of up to ₹10,000 in a savings account. This exemption is not available for mutual funds.

However, if you have large amounts to invest, a tax saving of mere ₹10,000 will not make the savings account a better option than STP through liquid funds in the long run.