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Liquid funds are a preferred option among investors seeking to create an emergency corpus. Read this article to find out what liquid funds are and the many benefits associated with this investment avenue.
Financial experts often encourage investors to set aside at least three months of expenses in an emergency fund. After all, the events in one's life may not always go as planned. The individual could lose his or her job, have a medical emergency, or the economy could head to another recession. Without any form of financial preparation, such scenarios could leave the individual devastated and stressed both mentally and financially. This is why it is essential to set up a contingency fund. The investment route that is typically recommended is the one that provides the combined benefit of capital safety with easy liquidity. Liquid funds are a popular investment channel that meet these criteria.
Liquid funds are a kind of mutual funds where money is put into in securities whose residual maturity is up to 91 days. They belong to the debt category of mutual funds, and invest in very short-term market instruments, such as government securities, treasury bills and call money. Liquid funds are becoming popular with retail investors on account of easy liquidity and the fact that their returns are greater than savings bank account. On submitting a redemption request, the investor will be able to get the money back within 24 hours.
These funds have the lowest interest risk as compared to the other classes of debt funds. They predominantly park money in fixed income securities that have a short maturity. Investors who are seeking to create an emergency fund must definitely consider investing in liquid funds. The returns they can receive are higher, and the money can be taken out quickly in the event of emergencies.
Here are some important elements that must be taken into account before investing in liquid funds:
Additionally, most fund managers invest and hold the security till the time of maturity. Thus, the fund does not incur expenses on account of excessive buying and selling of securities - which keeps the expense ratio low.
For taxation purpose, liquid funds are treated similar to other debt funds. If it is held for less than 3 years, then it shall be considered as Short-Term Capital Gain (STCG). However, if the investor holds for over 3 years, then it is regarded as Long-Term Capital Gain (LTCG). The tax treatment is different for growth and dividend plans. Investors are not taxed for dividends received under liquid plans, but fund houses are required to pay dividend distribution tax.
Through liquid funds, investors can gain from risk adjusted returns, accessibility and safety while maintaining a contingency fund. Thus, it would be wise to put money into such funds and begin an SIP for the purpose of setting up a contingency fund.