Liquid Funds: Everything You Should Know Before Starting Your Investing Journey

Parking money for the short-term

Have you received a lump sum amount and are figuring out where to invest it for the long term? People receive a lump sum amount in the form of an annual bonus, retirement benefits, sale proceeds from an asset, redemption or maturity proceeds from an asset, etc. They can temporarily park such amounts in a liquid fund. This article will discuss liquid funds and everything you should know about them.

What are liquid funds?

A liquid fund is an open-ended scheme that invests in debt and money market securities with a residual maturity of up to 91 days only. Fixed-income security may have a tenure of more than 91 days. For example, a security with a tenure of 6 months has already completed four months since its issue date. A liquid fund can invest in this security, as the residual (remaining) maturity is only two months, lower than 91 days. 

A liquid mutual fund invests in fixed income securities such as government securities (Treasury Bills and dated securities), non-convertible debentures (NCDs), certificates of deposit (CD), commercial paper (CP), etc. The objective of a liquid fund is more towards capital protection rather than generating returns on it. However, liquid funds do generate low to moderate returns for their investors.

Benefits of investing in a liquid fund

Some of the benefits of investing in a liquid fund include:

 

• Liquidity

 

The biggest benefit of some liquid funds is the instant liquidity they offer. Some liquid funds offer the “insta redemption” option. Under this option, an investor can redeem their liquid fund units, and the redemption money is credited to their bank account instantly through IMPS. However, there can be limitations on the amount that can be redeemed through this option. 

Some liquid funds have a limitation of 90% of the balance in the liquid fund or Rs. 50,000, whichever is lower, can be redeemed using the insta redemption option. The balance amount can be redeemed using the usual redemption option.

 

• Low credit risk

 

Liquid funds invest in fixed income instruments with the highest credit rating. Such instruments have a very low probability of credit default. Hence, these funds carry low credit risk. As mentioned earlier, the focus of a liquid fund manager is more towards capital protection rather than generating returns on it.

 

• Low expense ratio

 

Most liquid funds have a low expense ratio compared to other debt funds and equity funds. So, as an investor, if you are looking for a low-cost option for parking your surplus funds for a short-term tenure, then you may consider investing in a liquid fund.

 

• No lock-in

 

Liquid funds don’t have any lock-in period. So, you can redeem your units whenever you want. However, some liquid funds may have an exit load if you redeem your units before a specified period. For example, HDFC Liquid Fund has a tiered exit load if you redeem your units within six days.

 

Units redeemed within “X” days from the days of allotment	Exit load as a % of redemption proceeds
Day 1	0.0070%
Day 2	0.0065%
Day 3	0.0060%
Day 4	0.0055%
Day 5	0.0050%
Day 6	0.0045%

 

There is no exit load for redemptions from the 7th day onwards.

 

• Low-interest rate volatility

 

Liquid funds have low-interest rate volatility as they invest in fixed income securities with a residual maturity of up to 91 days only.

To know more about liquid funds, click on the link below: https://www.glideinvest.com/knowledge-center/liquid-funds-in-2022-liquid-mutual-funds-meaning-returns-benefits

Who should invest in a liquid fund?

As an investor, if you are looking for the following features, then you should invest in a liquid fund:

 

• Short investment tenure

 

If you are an investor who has received a lump sum but has not decided where to invest the amount, you may consider parking it in a liquid fund. Once you have decided how to deploy the money, you may transfer it from the liquid fund. As discussed earlier, liquid funds don’t have any lock-in period. However, some liquid funds have a nominal exit load if you redeem the units within seven days of investing.

 

• Easy access to funds

 

If you are an investor looking for easy access to funds at any time, you may consider investing your money in a liquid fund. For example, if you want to maintain an emergency fund, you can invest that money in a liquid fund. Through the insta redemption facility, a liquid fund can give you immediate access to your money at any time.

 

• Looking for alternative investment products to bank accounts

 

Many people keep their surplus money either in a savings bank account or a fixed deposit. However, savings accounts earn very low interest, and fixed deposits are not tax-friendly. So, if you are an investor looking for alternative investment products to bank accounts, you can consider investing in liquid funds. A liquid fund will give you decent returns, and the taxation is better than fixed deposits.

 

• Capital protection over returns

 

Some investors prefer to park their money in the safest possible investment product. Their main purpose is capital protection rather than earning returns on it. Such investors can consider investing in a liquid fund as it invests in fixed-income securities with the highest credit rating.

 

• SWP option for transferring to equity fund

 

Some investors prefer to park their lump sum in a safe product and then regularly transfer a small amount to an equity scheme. Such investors can park their money in a liquid scheme. They can use the systematic withdrawal plan (SWP) to transfer money to their desired equity scheme.

Taxation of liquid mutual funds

Liquid mutual funds are a subcategory under the broad category of debt funds. The taxation of liquid funds is similar to that of debt funds. Liquid funds are taxed as follows:

 

• Short-term capital gain (STCG) tax: If you sell your liquid mutual fund units before 36 months, the capital gain will be classified as short-term capital gain (STCG). The STCG will be added to your overall income and taxed based on your income slab.

 

• Long-term capital gain (LTCG) tax: If you sell your liquid mutual fund units after 36 months, the capital gain will be classified as long-term capital gain (LTCG). The LTCG will be taxed at 20% with indexation benefit or 10% without indexation benefit.