No doubt liquid mutual funds are considered as a better investment option to park your surplus money instead of holding as a savings bank balance. The reason is that these liquid funds provide liquidity, higher returns in comparison to their counterparts, and a lower interest rate volatility risk. You must invest in these funds if it fulfills your investment objectives for the chosen investment period. Now while selecting the best liquid funds to invest in 2021 you must consider a few factors to ensure to are making a well-informed decision. You need to consider the fund’s objectives, its credit score, maturity, historical performance, trends in NAV, past returns, and future prospects.
What are Best Liquid Funds?
Liquid mutual funds are high liquidity open-ended income schemes. They are a type of debt fund. The asset allocation of the funds is across short term market instruments such as treasury bills, commercial paper, government securities, fixed deposits, other debt or fixed income securities. These instruments have maturity up to 91 days.
Liquid mutual funds are considered to be a safe option to invest the surplus money lying in the savings bank account. Since the maturity period is less, they mitigate interest rate volatility risk. The credit risk or risk of default in repayment is also very low in these funds. Additionally, the fund manager ensures that they invest in instruments with good credit quality. Therefore, liquid mutual funds are the best option to invest for the short term.
NAV for liquid funds is calculated for 365 days whereas for other debt mutual funds NAV is calculated only for business days. The units of liquid funds are allocated as per the previous day’s NAV. The NAV of these funds does not fluctuate much as compared to other funds.
Liquid funds work just like a savings scheme. In other words, individuals can create their emergency fund or cash fund these funds.
What are the Advantages of Investing in Liquid Mutual Funds?
Liquid funds are considered as a better and safe option for investing surplus money when compared to its counterpart i.e. saving account balance. Top mutual funds carry a lot of benefits for an investor and become an ideal investment option. The advantages are listed below:
1. Fixed returns
The liquid fund invests in instruments which offer fixed interest rate and hence the returns received by an investor from them are also fixed. On maturity, an investor received the principal amount invested and the returns earned.
2. Low risk
The risk profile of liquid funds is low because of the below reasons
Low-interest rate volatility risk due to high liquidity and shorter maturity.
Since the maturity is up to 91 days only, the NAV of the underlying assets does not fluctuate much.
The credit risk or risk of default in repayment of principal amount and returns are also very low on these funds provided an investor invest in AAA or AA rated funds.
Due to the short term maturity of the instruments in which the fund invest, their liquidity tends to be high. An investor can anytime wish to withdraw the amount invested. The withdrawal request is processed within 24 hours of request raised. There is no lock-in period for these funds.
4. Higher returns
Liquid funds offer higher returns when compared to its counterpart i.e. savings scheme (savings bank account) balance, fixed deposit. While its counterpart offers 4% to 5% returns, these funds have delivered more than 7% historically.
Due to the above advantages, liquid funds have gained popularity in recent years amongst retail investors.
5. No exit load
Unlike fixed deposits and other mutual funds, no exit load is applicable to liquid funds. No exit load is charged if the investment is withdrawn after 7 days of investment.
What are the Things to Consider as an Investor?
Liquid funds are less risky when compared to similar funds in the category. The maturity of underlying assets is up to 91 days. Due to which the NAV does not fluctuate much as it is prevented from the price fluctuations of the underlying assets.
A fee known as expense ratio is charged to manage the investments in liquid funds. As per SEBI guidelines, the expense ratio must be under 2.25%. These funds maintain a lower expense ratio to offer a higher net return to an investor over a short period.
Liquid funds have delivered returns of more than 7% in the past. And these returns are anytime higher than a savings bank account (savings scheme) and fixed deposits (fd rates) which offer a 4% to 5% return. Since these funds have high liquidity, interest rate fluctuation risk is very low.
But NAV of liquid funds can drop significantly and unexpectedly. This can happen due to a decline in the credit risk rating of the underlying assets in the fund. Hence these funds are not completely risk-free.
Liquid funds are ideal for an investor who wishes to invest his surplus cash for a shorter period say up to 3 months. This investment horizon helps to utilize the full potential of the underlying securities. If an investor wishes to invest for a period say up to 1 year, he must consider investing in ultra-short-term funds to get relatively higher returns.
How to Choose the Best Liquid Mutual Funds?
The historical performance of a fund is an important parameter to consider while selecting the appropriate mutual funds to invest in. If a liquid fund that has performed well in the past, beating its benchmark and performing better than funds in the same category is a better option to invest. Then the fund can be expected to perform well in the future as well. Scripbox’s mutual fund screener helps in choosing the top performing liquid funds.
Maturity of the portfolio
An investor must choose the fund for which the maturity period matches his financial objective. If an investor chooses to invest for a period of 3 months or less then this fund is a better option. An investor with an investment objective up to 1 year he may consider investing in ultra short -term market instruments like liquid funds.
A liquid mutual fund with a shorter maturity period is considered to have a lesser interest rate volatility risk.
The credit score is a rating provided by credit risk scoring agencies like Crisil to cover default risk of repayment of principal amount and return earned. A higher credit risk score like AAA, AA ensures the credit risk is minimized. The risk of default in payment is low for the underlying assets in the fund with a high credit score. Therefore the fund manager ensures that they invest in instruments with good credit quality.
Who Should Invest in These Funds?
Liquid funds are ideal for an investor who has some spare cash for a short period and wants to earn a return higher than bank interest on savings bank account balance. An investor must park some emergency funds with himself as the redemption will be processed on the next working day.
An investor received Rs 100,000 as a bonus from his employer in May. He has a LIC premium due in July end. Now the funds are parked idle for him and he will need it in 2 months. Either he can invest in FD and lock-in his funds or park in a savings bank account. Both the options will fetch him a return of not more than 5%. Here he can think of liquid funds as a better option and invest for 2 months. This will fetch him higher returns with the freedom to withdraw anytime without any early exit fee.
How are Liquid Mutual Funds Taxed?
The tax implications on liquid mutual funds investment depend on the duration. The duration over which an investor stays invested is called holding period. A capital gain arises from these funds. A capital gain is taxed based on the period of holding of the investment.
Short term capital gain arises when the period of holding is less than years. Long term capital gain arises when the period of holding is more than 3 years. Short term capital gain will be added to an investor’s total income. And the investors are taxed as per their tax slab rate. And the tax slab varies as per the age of the investor.
Long term capital gain is taxed at a rate of 20% after indexation.
These funds do not help investors to save tax. For tax savings, one can invest in equity funds such as the ELSS fund.
Additionally, use the Scripbox’s Income Tax Calculator to determine the taxable income and best tax saver investment plans.
How to invest in Liquid Mutual Funds?
Investors can invest in liquid mutual funds either through Offline or Online technique.
Offline Investing: The mode of investing requires the investor to fill out all the details in the application form and submit documents like Aadhar card, pan card, and voter id, etc. with the fund house. The list of documents are:
- Identity Proof, for example: Aadhar Card
- Cancelled Cheque
- Passport size photographs
- Pan Card
- KYC Document (for KYC verification)
One can invest offline through a broker or self. Brokers help in choosing the best-suited funds by assessing all the factors. For all those who aren’t well versed with the markets can take the help of a broker to invest in the right set of funds.
Online Investing: There are multiple online platforms through which one can invest in mutual funds. Scripbox is one such platform that provides the best funds in the market for its investors. Scripbox algorithmically selects Mutual Funds and does an annual review of funds to ensure the fund’s performance and investor goals are on track.
What are the types of Money Market Instruments?
Liquid Mutual Fund schemes invest in money market instruments. These are certificate of deposits, commercial paper, and treasury bills.
Certificate of deposits: A deposit of money in a bank or a financial institution is a certificate of deposits (CD). It is similar to FD but differs in two ways. CD is only for large sums of money and CD is freely negotiable. CDs are highly liquid, considerably safe and give returns higher than t-bills. CDs are issued at a discount and the tenure ranges from 7 days up to an year.
Commercial Paper (CP): An unsecured promissory note issued by high rated companies to meet short term capital needs by raising money from the market. The tenure ranges from a day to 270 days. The returns are higher than t-bills but not as secured as them. CPs are traded in the secondary market.
Treasury Bills: Treasury bills (t-bills) are issued by the central government and are one of the safest investment option available in the money market. These are zero-risk instruments and hence the returns form these are not attractive. T-bills come with different maturity periods like 91 days, 182 days and 364 days and are issued a discount to their face value. They are circulated in primary and secondary markets.
Frequently Asked Questions
When should you invest in liquid funds?
An investor who has a surplus fund can invest in these funds rather than keeping the amount in the savings bank account. Investing in top mutual funds would mean earning a higher return than saving account interest and FD interest.
Are liquid funds tax free?
No, Liquid mutual funds do not help investors to save tax. For tax savings, one can invest in equity funds such as the ELSS fund. Use Scripbox’s Income Tax Calculator for best tax saver investment plans. Liquid funds taxation is similar to debt funds.
Do India liquid fund have a lock-in period?
No, liquid funds do not have a lock-in period. An investor can anytime withdraw the invested amount after 7 days of investing in these funds. No penalty or exit load is applicable to an early exit (post 7 days). Hence, it is a better option to invest in these funds since a fixed deposit would have a lock-in period and charge penalty for early withdrawal.
Is Liquid Funds better than FD?
Liquid funds are always a better option than FD as they giver higher returns than FD. Also, they have high liquidity. The current FD rates vary between 4-5% (post-tax). Their tax is slightly higher than FDs, but they are they do not have a lock-in period and there are no penalties for premature withdrawal like FDs.
How much should I invest in liquid funds?
An investor can invest his surplus or spare funds which he would not need soon up to 3 months or later. However, this fund will also be available to be withdrawn without an exit load or penalty.
What is the difference between debt fund & liquid fund?
India Liquid fund is a class of debt mutual funds. The asset allocation of the funds is across short term market instruments such as treasury bills, commercial paper, government securities, fixed deposits, other debt or fixed income securities. Liquid funds have a maturity up to 91 days.
Debt mutual funds are of several types like overnight funds, short term funds, ultra short term funds, gilt funds, medium and long term funds with multiple maturities. Liquid funds are the safest of all the debt funds available. Debts fund can be either a direct mutual fund or regular mutual fund.
Is liquid fund risk-free or how safe is your liquid fund?
Liquid funds have low risk as the maturity period is short. These funds invest in fixed income-generating assets like fixed deposit, treasury bills which have short-term maturity and low risk. However, one must consider the credit score as an important factor to know how safe is your liquid fund. The liquid fund with low credit score can lead to default risk.
Can we do SIP in liquid funds?
Yes investor’s can invest in liquid funds through SIP. But there is no point in doing that as their NAV remains more or less stable. SIP best works in high volatility and NAV is affected by market volatility. Instead, investors can do a lump sum in a liquid fund and do an STP in an equity fund. A standing instruction has to be given to the AMC as to when the STP has to start and how much should be transferred. The rest is done automatically. However, for investors interested in knowing the potential SIP returns can use the SIP calculator by Scripbox. Scripbox’s SIP calculator is completely online and free to use.
Can I invest a lump sum in liquid funds?
Yes, the fund house allows the investor to do lump-sum investment.