What are Liquid Funds? Should You Invest In Them?

Are you planning to invest your hard-earned money for just a short time and get better returns than your savings account? Or are you looking for a potentially low risk investment that can be easily withdr

Disclaimer:

In Unit Linked Policies, the investment Risk in the investment portfolio is borne by the policyholder.

Written by

Abhishek Chakravarti

BFSI Writer

Abhishek is a financial writer with over 6 years of experience in the BFSI sector. Prior to his current stint with Axis Max Life Insurance, he has worked with leading fintech startups. He specializes in writing about taxation and various investment products like ULIPs, retirement plans, guaranteed investment plans, mutual funds etc.

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Reviewed by

Sahil Rawal

BFSI Expert

Sahil Rawal is a digital & brand management specialist with over 10 years of experience in Financial Services Industry. Life insurance professional with expertise in digital marketing strategy, website content marketing and brand communication designed to increase brand awareness, drive engagement & sales.

Who Should Invest in Gilt Funds

Gilt funds are considered suitable for those that prioritize security above high returns and are seeking to stay invested for longer periods usually 3 years or longer. Historically, over the medium to long term, gilt funds have provided a good balance between capital preservation and reasonable returns. In addition, it offers superior asset quality of the underlying investment in comparison to equity funds and even many debt funds. These work well when markets are plummeting. High gains are provided by interest rate volatility, but the fund is also subject to interest rate risk.

What Are Liquid Funds?

Liquid funds are a type of debt mutual fund that invests in debt securities with residual maturity of 90 days or less. This type of mutual fund primarily investments of this scheme are debt and money market instruments, which include corporate and government bonds, debentures, Certificates of Deposit (CD), Commercial Papers (CP), Treasury Bills (T-Bills), etc.

A majority of these fixed-income securities are held till maturity, that combined with the short maturity of underlying investments makes liquid funds a potentially low volatility investment. As a result, liquid funds are considered ideally suited as a short term investment options by even conservative investors. However, returns from these mutual fund schemes is not guaranteed and dependent on performance of the investments debt/money markets.

How do Liquid Mutual Funds Work?

Before getting into the benefits and limitations, let us understand a bit more about the meaning of liquid funds. The main aim of a liquid fund is to offer a high degree of liquidity and capital safety to the investor making it an ideal short term investment option. To meet these objectives, the fund manager invests your amount into high quality debt instruments with an average maturity period of up to 90 days.

The short maturity of these investments helps reduce the interest-rate sensitivity of liquid funds and reduces the potential volatility of the investment. As a result, the fund value of liquid mutual funds does not experience a lot of fluctuations, making it a relatively low-risk market-linked investment option. Thus these mutual fund schemes are undoubtedly an excellent option for you to park your idle money while offering returns that are at par with or higher than fixed deposits of comparable tenure.

Features & Benefits of Investing in Liquid Funds

After understanding what are liquid funds, it is time to look at their key features and benefits. Knowing these details of liquid mutual funds can help investors make an educated decision regarding whether these schemes are a suitable investment for them:

Market Linked Returns

Liquid funds offer market-linked returns so returns from these schemes is not guaranteed. However, historically these debt schemes have offered comparatively higher return to investors in comparison to what bank deposits offer.

Low Volatility and Risk

As discussed earlier liquid funds are mainly invested in debt instruments with residual maturity of 90 days or less. More over these funds are primarily invested in high quality AAA and A1+ rated instruments that feature relatively low investment risk.

· High Liquidity

Liquidity refers to the ease with which an asset can be converted into cash. The redemption from these funds are typically credited to the investor’s bank account in 1 day. Moreover, there is no lock-in period with liquid mutual funds.

No Exit Load

The liquid funds usually have no exit load as long as units have been held more than 7 days. Therefore, with these funds, you can instantly redeem cash after 7 days without any penalty for premature withdrawal unlike fixed deposits or recurring deposits. This makes liquid funds an ideal option for maintaining emergency funds that can be easily withdrawn as and when required.

Minimum Investment

Liquid funds are undoubtedly better than bank fixed deposits as these funds are quite affordable. With only INR 500, you can invest in liquid mutual funds via a systematic investment plan (SIP). Also, the lump sum investing starts at INR 1,000 only. So, these funds are best for all those who are searching for an affordable investment option.

Flexibility

The liquid funds are offer with both growth and IDCW (Income Distribution cum Capital Withdrawal) options. So, the ones who are looking for capital appreciation can opt for the growth option, while those who are looking for dividend payouts can opt for the IDCW option.

Suitable for Conservative Investors

Liquid funds with their low volatility are suitable for even conservative investors who want their investment principal to be at the lowest possible level of risk.

Limitations of Investing in Liquid Funds

Now that we know what is liquid mutual funds and their key features and benefits, let us take a look at their limitations:

No Guarantee of Returns

Since performance of liquid funds are linked to the market, therefore, they also experience constant fluctuations. Thus, there is no guarantee of returns or safety of the principal amount invested in the scheme.

Management Fees

In the case of liquid funds, a fund manager will manage your investment portfolio, and therefore, they charge a fund management fee from the investor. This will decrease the potential returns from the investment as these fees and expenses are deducted from the returns generated by the scheme.

Taxability of Returns

Like other debt-oriented mutual funds, short term capital gains and long term capital gains taxation rules apply to investments made into liquid funds. The taxation of mutual funds in this category are also responsible for reducing the potential returns one can get from these investments.

Who Should Invest in Liquid Funds?

Liquid funds are considered a suitable investment option for those with substantial idle cash and looking for short-term investment options. Thus, liquid funds can be used for short-term parking of funds which may be later used for investment in equity via a systematic transfer plan. Also, this type of investment is also suitable for those who receive windfall gains or got a huge amount of money but have no idea where to invest their surplus funds. Additionally, the combination of low risk and high liquidity of liquid mutual funds also make them suitable for use as a way to keep your emergency funds handy.

Frequently Asked Questions (FAQs)

Do liquid funds are associated with exit load?

Can we do SIP in liquid funds?

Who is not qualified to avail tax exemptions under Section 80C?

Is it possible to invest in different types of instruments and claim a deduction of INR 1,50,000 for each?

Is investment in ULIP eligible for Sec 80C tax benefit? When can I withdraw?

Does Sukanya Samriddhi Yojana investment come under Section 80C? When can I withdraw?

What do you mean by 80C deduction under chapter VI A?

How to calculate deduction under Section 80C?

ARN NO: Aug23/Bg/04M

Sources:

www.incometaxindia.gov.in/Pages/tools/deduction-under-section-80c.aspx

www.incometaxindia.gov.in/pages/rules/equity-linked-savings-scheme.aspx

www.incometaxindia.gov.in/pages/rules/national-savings-certificates-viii-issue-scheme-2019.aspx

www.incometaxindia.gov.in/pages/rules/senior-citizens-savings-scheme-2019.aspx

www.incometaxindia.gov.in/pages/rules/nps-tax-saver-scheme-2020.aspx

www.india.gov.in/sukanya-samriddhi-yojna

www.indiapost.gov.in/Financial/pages/content/post-office-saving-schemes.aspx

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