What are Liquid Mutual Funds? – Benefits, Risks & Returns of Liquid Funds.

In this Samco Investor Education Series, we will cover the topic of what are liquid mutual funds. 

1. What are Liquid Mutual Funds?
2. Advantages and Disadvantages of investing in Liquid Mutual Funds
3. Returns and Risks
4. When to Invest?
5. Important things to look at before investing
6. How to Invest and Redeem Liquid Mutual Funds?
7. Tax Implications and Strategies 

What are Liquid Mutual Funds?

As per the new SEBI categorization, liquid mutual funds are debt mutual funds that can invest in securities with maturities of 1 day to 91-days. These securities include Treasury Bills, Government Securities, Call Money among other Debt securities. Many mutual fund advisors ask investors to park their surplus funds and a part of their contingency funds in liquid funds. Liquid mutual funds are the least risky among debt mutual funds and they have the potential to offer marginally higher returns than bank deposits as the returns are linked to the market.

Advantages and Disadvantages of investing in Liquid Mutual Funds:

Advantages

1.  Preservation of capital as it is a very safe investment avenue.
2.  Very low-risk investment.
3.  Offers higher returns than funds in savings accounts & fixed deposits.
4.  No Exit and Entry Load.
5.  Much more flexible than fixed deposits, as it is not invested for a fixed amount of time and can be redeemed at any time without exit loads, whereas breaking the FD before its maturity attracts a pre-maturity penalty.
6. Quick redemption and proceeds are received in one day or instantly with few funds.
7. A partial amount can also be redeemed which is not possible with fixed deposits.
8. Liquid Mutual Funds Schemes score high on returns and low on tax outgo as compared to FDs.

Disadvantages

1.  Lower returns as compared to equity based  funds.
2.  The interest is lower than a few of the fixed deposits offered by banks for a term of a year.
3.  Liable to Short term Capital Gains Tax if held for less than one year, i.e. chargeable at slab rates, thus more tax for investors in the higher tax bracket.
4.  Liquid schemes are a little riskier than fixed deposits as they carry credit risk.

Returns and Risks:

1) Risks

• Liquid Mutual  funds, like any other mutual fund scheme, invest in securities that have a market price. When market price of these securities moves up or down, so does your mutual fund's net asset value (NAV). But a liquid fund's NAV doesn't move up or down as much as other funds. This is because, as per SEBI’s rules, securities that have maturities less than 60 days are not required to be marked to market.
• The only change in the NAV of the fund is the interest added to the securities and divided. Thus, NAV is a line moving gradually up. But, this does not mean that liquid funds are entirely risk-free, as liquid funds are allowed to invest in securities which have maturities ranging to 91 days.
• Typically, liquid funds are invested in securities with high credit ratings, but there are few funds which may invest in securities which may default and lead to a downgrading of rating and thus bringing down the NAV of the fund. Also, there is a very thin chance that liquid fund may give negative return in case of extreme interest rate volatility.

2) Returns

Investors can reasonably expect liquid funds to return around 6-9% before tax returns in a year.

When to Invest?

Liquid funds are used by investors to park their money for short periods of time from few weeks to months. You can use it in the following situations:

1. You use it if you have excess cash and think you might need the cash in a few days or weeks or months.
2. If you wish to invest a large sum in an equity fund, but want to stagger the investments over a period, put your money in a liquid fund and enroll for a systematic transfer plan (STP) whereby you invest a fixed sum from your liquid fund to an equity fund each month.
3. They are ideal parking grounds when you have a sudden influx of cash either because you have received money from any legal settlement or from maturity of investments and don’t have any immediate use of such funds.
4. When there is a planned expenditure like a holiday, school fee instalments, diwali shopping expenditure or such other expenditure which is not due for 2-3 months, you could invest in liquid funds.
5. Usually, investors maintain a contingency fund or a rainy day fund which can also be parked in Liquid funds.

Important things to look at before investing:

1. Minimum investment amount which will vary from Rs. 500 to Rs. 5,000 depending on the liquid fund  provider.
2. Expense Ratio which usually varies from 0.04% to 0.15%.
3. Whether to select Growth or Dividend schemes.
4. CAGR Returns for the past 1-year, 3-year and 5-year periods.

How to Invest and Redeem Liquid Mutual Funds?

Investors can buy Liquid Funds in the following ways:

1. From Mutual fund Distributors
2. Directly from websites of Mutual funds
3. From various online Direct Mutual funds distributors

Liquid funds are highly liquid investment vehicles which can be redeemed very easily without any exit loads and the money is deposited in investor’s account within a day. Soon, arrangements will be made that the funds of the investors are deposited within a few minutes.

Tax Implications and Strategies:

Liquid Funds are treated as any other debt security on capital markets when it comes to taxation. If liquid funds are held for more than three years then the gains are taxable at a rate of 20% while if held for less than three years then taxable as per the tax slab.

It is a no brainer for investors who belong to the 30 per cent tax bracket to go for liquid funds over bank FDs if they wish to stay invested for three years or more. Because long-term capital gains in liquid schemes held for three years or more are taxed at 20 per cent with the indexation benefit. Interest income earned on a bank FD, on the other, is added to the income and taxed according to the income tax slab applicable to the investor. Bank deducts 10 per cent tax at source on FD if interest income in a year exceeds Rs 10,000.

To summarize, Liquid funds offer safety, reasonably good returns (in comparison to savings accounts or even very short-term fixed deposits) and full flexibility of redemption any time without any exit loads.

List of Top Five Liquid Mutual Funds:

1) All the above funds are open-ended funds.

2) They are measured against the benchmark Crisil Liquid Mutual Funds Index.

That covers in-depth information about Liquid Mutual Funds. For more useful articles on Mutual Funds, trading, investing and market knowledge, visit our Investor Education section.

(Note: This content is for information purpose only. Avoid trading and investing based on the information given above. Before investing in stocks or mutual funds, please conduct proper due diligence).