Liquid Mutual Fund

A Liquid Mutual Fund is a debt fund that invests in fixed-income instruments, such as treasury bills, commercial papers and certificates of deposit. Liquid mutual funds invest in securities that have a residual maturity of up to 91 days. The best part about investing in liquid funds is that they have the lowest interest rate risk among debt funds.

One of the significant benefits of investing in liquid mutual funds is that they offer steady returns with relatively low risk, making them ideal for short-term financial goals. These investment tools are often preferred over fixed deposits due to their faster liquidation and greater flexibility.

Because liquid mutual fund investments are not locked in, investors can redeem the funds easily during emergencies. The Net Asset Value (NAV) is calculated on a daily basis for 365 days, and the cut-off time for redemption is typically 3:00 PM in India.

Here is how liquid mutual funds function for investors:

• The fund managers invest in debt instruments with maturities up to 91 days.
• These include commercial papers, certificates of deposit and treasury bills.
• These instruments are designed to deliver consistent and stable returns on liquid fund
• The financial instruments have lower interest rate risks due to shorter tenures.
• Investors can enjoy quick redemption, often within 24 hours.
• Gains on liquid mutual funds are subject to applicable tax.

If you are looking for an investment option with lower risk, consider liquid mutual funds. But before you do so, here are some points to consider:

• Liquid mutual fund investment is ideal for investors who prefer safety and steady returns over risky and high-reward opportunities.
• The benefits of mutual funds are greater than keeping money idle in a traditional savings account, as they usually offer better returns.
• Many investors use liquid mutual funds as a temporary parking space for surplus funds, especially when they plan to invest in equity later.
• Liquid mutual funds serve as a great starting point for investors who are not yet ready to invest in the stock market due to its high volatility.
• The funds are suitable for short-term goals and emergency funds due to the quick redemption time of liquid funds.

Like any other form of investment, there are both advantages and disadvantages to investing in liquid mutual funds. Here is a list of things that you need to keep in mind when investing in liquid funds:

Risk

As mentioned earlier, liquid mutual funds are low-risk investments because they invest in securities with a maturity period of up to 91 days. However, there are no guarantees since liquid funds are also linked to the market. Liquid funds mostly invest in AAA-rated papers, which makes them reasonably secure.

Returns

In comparison to a savings account, liquid fund returns are far better. This is why they are considered a better investment option for those seeking a higher rate of return. Liquid funds invest in fixed-income instruments, such as commercial paper, treasury bills, and government securities, which ensure steady returns.

Expense Ratio

Similar to other mutual funds, liquid funds also incur certain charges, known as the expense ratio, which serve as maintenance fees. Most fund managers seek the best liquid funds to invest in, characterised by lower expense ratios, for improved returns in liquid funds. However, liquid funds are held up until maturity, which reduces the expense ratio for that particular debt fund. The lowered cost of maintenance also contributes to the overall returns, making liquid funds a lucrative investment option for investors seeking a low-risk opportunity.

Liquidity and Redemption Time

Liquid mutual funds are highly liquid and are often used as an emergency fund by many investors. One of the key features of liquid funds is the quick redemption time, as some funds offer instant redemption of up to INR 50,000 per day per investor. For others, the redemption proceeds are generally credited within one working day. This feature makes liquid mutual funds an ideal investment option for investors seeking fast access to their money during unexpected financial events.

Investment Horizon

Liquid mutual funds are best suited for short-term goals or surplus funds that an investor may need in the near future. A typical liquid investment horizon ranges from 1 day to 3 months. While these investment tools provide capital safety and liquidity, they are not designed for long-term wealth accumulation.

Tax on Liquid Funds

Taxation is a critical factor when evaluating investment returns. If liquid mutual funds are held for a period less than three years, the gains are considered Short-Term Capital Gains and taxed as per the investor’s income tax slab. On the other hand, funds held for more than three years (although not typically for liquid funds) are subject to Long-Term Capital Gains Tax, which is applicable with indexation benefits. Understanding tax on liquid funds helps in calculating net returns more accurately.

Portfolio Transparency

Transparency is key in choosing the best-suited investment tool. Reputed liquid funds publish their portfolio holdings regularly, allowing investors to assess the quality of the underlying assets. Reviewing this data ensures that your investment is placed in credible, low-risk instruments, reinforcing confidence in your liquid fund investment decision.

Exit Load and Cut-off Timings

Most liquid funds do not charge an exit load if an investor keeps their investment for more than seven days. However, if redeemed earlier, some funds may levy a small fee. Also, please note that the 3:00 PM cut-off time applies to the same-day NAV applicability. Transactions placed beyond this time are processed on the next business day. This timing plays a crucial role in determining the number of units you receive or the final redemption value.

Liquid mutual funds come with a set of features that make them an attractive investment option for short-term parking of funds. The key features include:

• Liquid funds typically invest in debt instruments that have a maturity of up to 91 days, making them suitable for short-term goals.
• These funds carry minimal interest rate risk due to their short tenure as investments.
• The Net Asset Value (NAV) remains relatively stable, offering consistency in liquid fund returns.
• Investors can enjoy quick and hassle-free redemptions, with some asset management companies offering instant withdrawal options.
• Fund managers select high-quality instruments like treasury bills, commercial papers and government securities to optimize liquid fund returns.
• These funds are transparent, and investors can regularly monitor their performance through updates and disclosures.

Liquid mutual funds offer a range of advantages for investors seeking low-risk short-term investment options with better returns than conventional savings methods. The key benefits include:

• Liquid fund returns are generally higher than the interest offered by regular savings accounts.
• These funds involve low credit risk, as they primarily invest in AAA-rated debt instruments.
• Liquid fund investments offer excellent liquidity, making them ideal for building an emergency corpus.
• There is no exit load if an investor stays invested for more than seven days, offering added flexibility.
• Investors can use liquid fund investments to gradually enter equity markets through STPs, reducing exposure to market volatility.
• Understanding the tax levied on liquid funds may help investors plan short-term and long-term capital gains efficiently.

An investor may consider investing in liquid mutual funds when they have surplus money that they do not wish to leave idle in a savings account but still want to keep easily accessible. These funds are ideal for short-term financial goals, like setting aside funds for an upcoming travel plan, insurance premium or any expense within the next three to six months. These funds are also suitable when an investor is looking to build an emergency corpus, thanks to their quick liquid fund redemption time and low market volatility.

First-time investors often begin with liquid mutual funds to understand how mutual funds work before moving on to equity-based instruments. Moreover, if a beginner investor is waiting to enter the stock market gradually, investing in liquid funds and opting for the Systematic Transfer Plan can be a smart move.

Understanding what a liquid fund is and how it fits an investor’s needs helps ensure better financial planning and steady, low-risk investment growth.

Finding the best option for liquid mutual fund investment involves looking at several key parameters, which include:

• Looking at the credit rating of the fund’s portfolio. Funds that invest in AAA-rated instruments are generally more secure.
• A lower expense ratio helps improve an investor’s overall liquid fund returns, especially when held for a short period of time.
• Checking the fund’s recent performance over three to six months to understand its consistency and stability is considered a good practice.
• Reviewing the liquid fund redemption time is also important. Some funds offer instant redemption while others may take up to 24 hours.
• Choosing funds managed by reputed asset management companies with a proven track record and experienced fund managers.
• An investor must always read the scheme documents thoroughly before signing the agreement. The key considerations include the fund’s objective, investment strategy and risk level.
• Understanding what a liquid fund is and comparing funds across platforms makes it easier to grasp the meaning of liquid funds and make an informed decision.

Before making a liquid mutual fund investment, it is important to understand how taxes apply to the returns you earn. Like all debt mutual funds, liquid mutual funds are subject to capital gains tax based on the holding period.

• If an investor redeems their points within three years, the profits are treated as short-term capital gains and taxed according to their income tax slab.
• There is no long-term capital gains benefit on liquid funds post the 2023 tax rule changes for debt mutual funds.
• The gains are added to an investor’s annual income and taxed accordingly. This makes the tax on liquid funds less favourable for high-income investors if held in the short term.

One of the key advantages of investing in liquid mutual funds is the ease and speed with which funds can be accessed. The average redemption time for liquid funds is generally within 24 hours, making them an excellent choice for short-term parking of surplus funds. Some asset management companies may offer instant redemption facilities, allowing investors to withdraw funds up to a specified limit (usually INR 50,000 or 90% of the invested amount) directly into their bank account.

For other funds, if the redemption request is placed before the cutoff time (usually 3 PM), the amount is credited the next working day. This quick-access feature distinguishes liquid mutual funds from traditional fixed deposits and is particularly useful during financial crises.