What are Liquid Mutual Funds?
- 6 min read
Do you know that in a particular mutual fund, you can invest your money and redeem it quickly? Just like a savings account, liquid funds provide you with this facility but with higher returns.
Sometimes, investors face challenges in turning their investments into cash. To avoid this challenge, this blog provides an in-depth analysis of what are liquid funds, how they work, and how to start investing in them.
What Do Liquid Funds Mean?
Liquid mutual funds are a type of debt funds that have a maturity period of up to 91 days. They make investments in fixed-income assets such as government securities, commercial paper, and treasury bills.
Additionally, investors have 24 hours to complete their withdrawals. Among debt funds, these funds have the lowest interest-rate risk. These categories of mutual funds investment benefit investors due to their stability and safety.
Depending on the credit quality of the scheme’s underlying instruments, liquid funds provide both capital protection and high liquidity. You can redeem money from these funds on a T+1 basis, or in a few days or weeks.
How Liquid Funds Function?
Liquid funds offer capital protection and liquidity to the investors. Hence, the fund manager makes investments following the scheme’s objectives and chooses premium debt securities. Additionally, it guarantees that the portfolio’s average maturity will not exceed 91 days.
A fund with a shorter maturity is less vulnerable to fluctuations in interest rates. The fund management attempts to provide higher returns by aligning the maturity of individual assets with the maturity of the portfolio. Liquid funds also yield higher returns than traditional savings accounts.
Who Can Invest in Liquid Funds?
As you understand the liquid funds meaning, you should know who can benefit the most by investing in them:
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Short-Term Investors
Investors who have extra money and want to make short-term investments can invest in liquid funds. This can yield larger returns than a current account or savings account.
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Investors Looking for Equity Funds
People who are transitioning to more growth-oriented assets, such as equity-based funds, may find liquid funds useful. Their consistency and liquidity make them a desirable choice for investors who want to increase their risk tolerance.
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Cash Reserve Holders
People with extra cash in hand can invest in these funds. They offer a place to save extra money and yield greater returns than standard investment methods.
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Emergency Fund Builders
Due to liquidity, competitive returns, and minimal risk, investors can use liquid funds as emergency savings. These funds provide easy access to money during emergencies.
What are the Benefits of Investing in Liquid Funds?
Along with providing higher liquidity, liquid funds offer numerous benefits for investors. Some of them are:
Lower Risk
Cautious investors can put their money in high-quality debt instruments with short maturity periods. Funds with maturity periods up to 91 days can bring consistency in their profile.
Higher Returns
Liquid funds provide consistent returns during inflationary times. It makes them a top choice for investment with modest but reliable returns.
Low Exit Loads and Expense Ratio
More of your returns remain with you when your expense ratio is lower. The expense ratios of liquid funds are lower, ranging from 0.1% to 0.3%, compared to those of equity funds, which range from 1% to 2%.
Download the PL Capital Group – Prabhudas Lilladher application and invest in different categories of mutual funds. PL also allows you to open a Demat account for free.
Taxes on Liquid Funds
Investors can avoid paying taxes on dividend income from liquid funds. However, a capital gain that is realised by an investor who redeems the fund’s units at a price higher than the purchase price is subject to taxes.
The total time you retain liquid funds determines the taxes you must pay. You will be subject to short-term capital gains (STCG) tax at your income tax bracket rate if you sell within 2 years.
You will have to deal with long-term capital gains (LTCG), which are taxed at a fixed 12.5% rate and have indexation advantages if you hold for more than 2 years.
Final Thought
Liquid funds can be a profitable and safer investment option for short-term investors, cash reserve holders, and emergency fund builders. These funds predominantly invest in short-term debt securities with a maturity period of less than 91 days. Investing in liquid funds can lower your risk and provide higher returns.
Download the PL Capital application to invest in mutual funds from 45+ mutual fund houses. Investing in mutual funds with PL allows you to generate higher returns than the benchmark.
Frequently Asked Questions
1. Are taxes applicable to liquid fund returns?
Yes, both STCG and LTCG taxes apply to liquid fund returns. If you sell your investments within 2 years, you will have to pay STCG tax at your income tax bracket rate. Additionally, you will have to pay LTCG tax of 12.5% if you hold for more than 2 years.
2. Can we start SIP in liquid funds?
Yes, you can start a systematic investment plan (SIP) in liquid funds.
3. Does a liquid fund perform better than a fixed deposit?
The returns of liquid mutual funds and short-term fixed deposits (FD) are nearly the same. To some extent, liquid funds are better than FDs. For starters, there is no commitment to a lock-in term, and if you decide to stop investing after seven days, there is no penalty.
4. Is there any lock-in period in liquid funds?
No, there is no lock-in period in liquid funds, as you can use them whenever needed.
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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
