Why you should invest in liquid funds

Liquid funds are classified as debt-based funds that majorly deploy their investments in fixed-interest generating instruments in the money market for the short term.

These may include commercial paper, treasury bills, and other such instruments with maturity periods within a maximum of 91 days.

These funds strive to ensure higher liquidity levels along with greater capital safety as far as investors are concerned. Naturally, fund managers make investments in debt instruments with high credit quality, and the proportions allocated are based on the investment goals of the fund in question. Fund managers also make sure that average portfolio maturity stands at approximately 3 months.

Wondering how to invest in liquid funds? These funds are not as sensitive to changes in rates of interest. The value of the fund is not subject to high fluctuations and, additionally, the maturity of underlying securities is matched to portfolio maturity as well.

These funds are great choices for parking money, which otherwise lies idle in your savings account. They are usually low-risk investment options that have higher returns as compared to savings accounts, and they do not attempt to mimic the liquidity component of a savings account while bypassing exit loads. You can easily withdraw money at your own convenience.

Investing in liquid mutual funds – Things worth keeping in mind

Before Investing in big funds like Nippon India Liquid Fund or similar liquid funds, you should have a proper knowledge of these market instruments:

• CD (Certificate of Deposit) – These are time-based deposits akin to fixed deposits that are offered by SCBs (scheduled commercial banks). The difference here is that you cannot withdraw CDs prior to the expiry of their term.
• CP (Commercial Paper) – These are mostly issued by companies and financial institutions with higher credit ratings. They are also called promissory notes and are mostly unsecured instruments that are issued at discounted rates and come with face-value redemption. The differences lie in the returns which are earned by investors.
• T-Bills (Treasury Bills) – These are released by the Indian Government for raising money for a short period of up to 365 days. These are the safest financial instruments since they are backed by government guarantees. The rate of return or risk-free rate is lower in the case of treasury bills as compared to other market instruments.

Should you be investing in liquid funds?

When it comes to deploying investments in low-risk liquid funds like Mahindra Manulife liquid funds or other similar instruments, you should consider the same when you have surplus cash in your account that can be committed for a shorter tenure.

These funds will be invested in the money market and short-term debt instruments (up to 91 days) which are rated highly, ensuring better returns and liquidity in sync with prevailing conditions in the market.

Here are the key advantages worth keeping in mind:

• There are minimal risks to the capital since liquid funds come with high ratings and indicate minimal losses owing to credit defaults. These schemes make investments in market instruments with 91-day maturity profiles, lowering volatility-related risks, and capital risks.
• Investors can get returns from the investment date itself, thereby lowering the chances of any leakage of returns.
• Investors may invest for time periods as low as a single day for optimal fund usage and cash management.
• Along with conventional redemption methods, these funds also enable access to investments anytime.
• There are zero exit and entry loads.

These funds are ideal for those with adequate surplus/idle money and those who are seeking short-term investment options. Rather than putting surplus money in a savings account, it can be invested in a liquid fund instead. Excess funds come with incentives (performance-based), gains, and bonuses through the sale of capital assets.

Liquid funds may be used as a suitable medium for investing in equity funds. The cash may be invested initially in a liquid fund prior to executing a systematic transfer to any chosen equity fund over a particular time period.

What investors must keep in mind?

Liquid funds come with several investment dos and don’ts, including the following:

• Risk Levels – In these cases, risks are linked majorly to NAV (net asset value) fluctuations. In the case of liquid funds, NAV will not frequently fluctuate since maturity periods of underlying assets are usually between 60 and 91 days. This prevents the NAV of the fund from getting affected considerably by fluctuations in the prices of underlying assets. Yet, fund values may suddenly reduce owing to a downgrade in the credit rating of the underlying security that is held. The risk levels are not entirely absent.
• Returns – Liquid funds have usually generated profits between 7-9% over the years, which is considerably higher in comparison to savings bank account returns of 3.5-4%. Although returns do not have any guarantees, these funds have ensured positive returns in most cases.
• Costs – A fee will be charged for the management of investments and this is known as the expense ratio. SEBI (Securities and Exchange Board of India) has made it compulsory that the maximum expense ratio will be 1.05%.
• Investment Period – These funds are meant to deploy surplus money over a shorter span, i.e. up to 3/4 months. You may consider ultra-short-term funds for getting comparatively higher returns if you have an investment timeframe of up to 1 year or so.
• Financial Objectives – Liquid funds are useful for creating an emergency corpus to take care of exigencies down the line.
• Taxation – Whenever you make any investments in debt funds, your capital gains will always be taxable. The taxation rate is dependent upon the time frame during which you stay invested in the fund in question. This duration is known as the holding period. Gains in the first three years are called STCG or short-term capital gains, while capital gains made over a period of three years or higher are known as LTCG or long-term capital gains. STCG arising from debt funds will be added to the income of the investor and will be taxed on the basis of his/her income category/slab. LTCG arising from debt funds will be taxed at 20% post-indexation.

Keeping these aspects in mind will help you immensely when it comes to investing in liquid funds. They can actually prove to be rewarding investments although they are not fully risk-free.

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