• Investment
  • Car
  • Bike
  • Taxi
  • Term Life
  • Health
  • Travel

Liquid Fund

Liquid funds are debt mutual funds where funds are invested in short-term market instruments like treasury bills, commercial papers, government securities and certificate of deposits. They are invested in securities with a maturity of up to 91 days, allowing investors to park their money for short periods, like 1 to 3 months. Liquid funds are a suitable option for those investors who have excess cash and think they might need it in a few days or weeks or months. Liquid funds are the least volatile and least risky among the various debt funds. This is because they are mostly invested in highly-rated instruments. Now, given that they carry a low level of risk, such funds have been assigned blue colour, as per codes specified by the Securities and Exchange Board of India.

Liquid funds are suitable for investors with substantial idle cash, seeking short-term investment havens. Rather than parking that money in a savings bank account, investing it in liquid funds can fetch better returns. One can also use this as a medium to invest in equity funds. An investor can first put his or her money in a liquid fund and then enrol for a systematic transfer plan (STP), whereby a fixed sum of money from the liquid fund is invested in an equity fund of the investor's choice over a specified time period. Liquid funds come with different plans such as daily dividend plan, growth plans, weekly dividend plans and monthly dividend plans. Dividend is not declared in case of growth plans, and the fund's appreciation is reflected in higher unit value. Investors can make their choice of plan according to their convenience and liquidity needs. Direct plans are more suitable for retail investors as they have a lower expense ratio, which in turn helps them fetch a higher return.

Benefits of Liquid Funds

The following are some of the benefits enjoyed by investors who choose to invest in liquid funds:

  • Liquid funds have the potential to earn better returns compared to a savings bank account or current account.
  • Liquid funds are the least volatile since they are invested in instruments carrying high credit rating.
  • Most liquid funds do not have exit loads.
  • Liquid funds, when compared to other debt funds, have been seen to have the lowest interest rate risk. This is because the investments are primarily made in fixed income securities with short term maturity.

Features of Liquid Funds

Liquid funds are open-ended debt mutual funds where investments are primarily made in short-term money market instruments, with a maturity of up to 91 days. Funds are invested in instruments like treasury bills, commercial papers, term deposits, etc. The features of liquid funds are as under:

  • No Entry and Exit Load - Liquid funds generally do not have entry or exit load, given that they are highly liquid in nature.

  • Low Annual Fee - Liquid funds feature a low annual fee, ranging from 0.30% to 0.70%

  • Return on Investment - Liquid funds help fetch about 8% rate of return on the money that is invested. In case of parking funds in a savings bank account, the rate of return is about 4%. As inflation rises, the RBI increases interest rates, and during such times, liquid schemes give high returns.

  • Variable Minimum Investment - The minimum amount to be invested in liquid funds will vary from one scheme to another.

  • Easy Liquidation - Liquid fund withdrawals can be made in a very short span of time, which can be a day.

  • Low Interest Rate Risk – Compared to all the other debt funds, liquid funds have the lowest interest rate risks. This is because liquid funds mainly invest in fixed income securities that have a low maturity period.

  • Convenience - There are a number of investing options under liquid mutual funds. These include monthly daily dividend plans, dividend plans, weekly dividend plans and growth plans. Investors can choose in which plan to invest in, as per their convenience, on the basis of their liquidity needs.

How do Liquid Funds Work?

For investors, liquid funds provide a high degree of liquidity as well as safety of capital. The fund manager allocates the funds of the investor in high-credit quality debt instruments of varying proportions, according to the fund's investment mandate. The fund manager will make sure that the portfolio's average maturity is up to 3 months. The returns are therefore least affected by the overall interest rate fluctuations in the economy. The maturity of the underlying securities is then matched to the portfolio maturity with the intention to fetch higher returns.

In case of other debt funds, the Net Asset Value (NAV) is calculated only for business days, whereas in the case of liquid mutual funds, the NAV is calculated for 365 days. The NAV of liquid funds does not fluctuate much as the other funds, making it a low-risk instrument. Its units get allotted according to the previous day’s NAV, if the application is handed over before 2 p.m. Withdrawal requests get processed in about 24 hours.

Things to Consider as an Investor

Before putting money into liquid funds, one needs to clearly understand how liquid funds work. Liquid funds function rather differently from other investment avenues, and hence not the ideal choice for every kind of investor. Here are a few essential factors that need to be taken into consideration by anyone intending to invest in liquid funds.

  • Risk - The risk in mutual funds generally comes down to the fluctuations seen in the Net Asset Value (NAV). In the case of liquid funds, the NAV does not fluctuate too often since the underlying assets mature within 60-91 days. This helps in ensuring the fund NAV is not too impacted by the underlying asset price fluctuations.

  • Investment Horizon - Investing in liquid funds are suitable for those seeking to invest surplus cash for a very short period of time, up to 3 months. The short horizon helps in realizing the complete potential of the underlying securities.

  • Cost - A fee will be levied to manage the money in liquid funds, known as an expense ratio. Until now, SEBI has fixed the upper limit of expense ratio to be 2.25%.

  • Financial Goals - If the goal is to create an emergency fund, liquid funds can serve this purpose. Besides helping generate higher returns, such funds enable the investor to take money out easily, in the event of emergencies.

  • Returns - It has been observed that liquid funds generate returns in the range of 7% to 9%. This is higher compared to the 4% returns one can make through investments in savings bank account. Although there is no assurance provided on the returns on liquid funds, in most cases, they have helped fetch positive returns upon redemption.

How to Invest in Liquid Funds?

Investors in liquid mutual funds benefit from good liquidity and low interest rate risk. It is considered one of the best parking options for corporate and individuals alike. Factoring in all these reasons, liquid funds can be viewed as a good alternative to fixed deposits. Most of the schemes offer redemption process where funds are deposited back into the bank account in just a matter of a day. Investors can easily their money into liquid mutual funds by contacting a broker or through the website of a fund house. Personal details, along with the investment amount and period of investment will need to be communicated.

Investors will find that they can choose from a number of different liquid funds. One essential point to be noted is that from the point of view of performance, there isn't much of a differentiation among them. However, for individuals who wish to analyze how liquid funds have performed, the right method would be to compare the performance against that of the benchmark and of the peer group.

Why Invest in Liquid Funds for the Short Term

Considering the present state, low-interest rates appear to be the norm, and most experts are expecting further rate cuts will be announced going forward by the Reserve Bank of India. Although this seems like the ideal time for people seeking to avail loans, it put prospective investors in a pickle. This is due to the fact that interest rate cuts also impact the ROI from traditional routes like fixed deposits, EPF, PPF, etc. As these routes will seem less lucrative for potential investors, alternatives need to be found. Debt fund is a very popular short-term investment route in the present scenario, which generates annual returns of about 10%. Investing via this mode is a good option since it is highly liquid and less prone to volatility, when compared with equity funds. Therefore, investors looking to invest surplus funds have increased debt fund investments, like liquid funds, in recent times as against keeping this in a low ROI option, like a savings account.

Returns and Risks of Liquid Funds

Liquid funds, just like the case with other mutual fund schemes, are invested in securities that come with a market price. As the market price goes up or down, so will the mutual fund’s Net Asset Value (NAV). However, the NAV of a liquid fund does not fluctuate as much as that of other funds.

According to the rules set by SEBI, if a security were to mature in less than 60 days, it does not have to be marked-to-market. Only the interest component has to be included. In other words, the interest earned through the debt fund during the security's tenure will divide the total interest component equally for the number of days that the security is held. The price of the security shall stay steady. Thus, the NAV movement of the liquid fund is linear - a steady line going up. This, however, does not imply that liquid funds are free from risk.

Liquid fund can invest in scrips, which mature up to 91 days. So, if investments are made in scrips maturing between 60 and 91 days, it will need to be marked-to-market, based on its credit rating. If an underlying company defaults on its interest and/or principal repayment, the scrip’s credit rating as well as its market price will go down. Should your liquid fund be invested in such a security, the NAV will decrease too.

Taxation Rules for Liquid Funds

Liquid funds are taxed similar to other debt funds. In case the funds are sold before the end of three years, the investor will have to incur short-term capital gains tax. The tax rate will depend on which income tax slab the individual falls in. If the funds are sold after three years, then long-term capital gains tax will apply, which will be levied at 20% with indexation and 10% without the benefit of indexation.

Top Liquid Funds to Invest in India

Here is a look at some of the popular liquid funds in the market:

Fund Name3 Year5 Year
Taurus Liquid Fund7.3%8.1%
Aditya Birla Sun Life Floating Rate Fund8.0%8.7%
Principal Cash Management Fund7.3%8.1%
Axis Liquid Fund7.3%8.1%
BOI AXA Liquid Fund7.3%8.1%
Essel Liquid Fund7.4%8.1%
Aditya Birla Sun Life Cash Plus7.4%8.2%
Baroda Pioneer Liquid Fund7.3%8.1%
UTI Liquid Cash Fund7.3%7.4%

FAQs on Liquid Funds

What are liquid funds?

Liquid funds are debt mutual funds where funds are invested in short-term market instruments like treasury bills, commercial papers, government securities and certificate of deposits. They are invested in securities with a maturity of up to 91 days, allowing investors to park their money for short periods, like 1 to 3 months. Liquid funds are a suitable option for those investors who have excess cash and think they might need it in a few days or weeks or months.

Is income from liquid funds taxable?

Liquid funds are taxed similar to other debt funds. In case the funds are sold before the end of three years, the investor will have to incur short-term capital gains tax. The tax rate will depend on which income tax slab the individual falls in. If the funds are sold after three years, then long-term capital gains tax will apply, which will be levied at 20% with indexation and 10% without the benefit of indexation.

What are the options available to investors in the debt funds category?

Broadly, debt funds, can be divided on the basis of open and close-ended debt funds. Open-ended debt funds tend to be the bigger of the two in terms of the total assets that are managed. Liquid funds fall under the category of open-ended debt funds.

In liquid funds, the taxation would be the same as the interest that you earn from a savings account?

They are marginally lower however, they are rather similar to one would have to pay in a bank fixed deposit.

Do the returns differ from liquid to short-term to ultra-short-term funds?

Liquid funds are invested in securities with a maturity of up to 91 days, allowing investors to park their money for short periods, like 1 to 3 months. Ultra-short-term funds are those where money is invested in fixed-income instruments that mature anywhere from seven days to 18 months. It is suitable for investors who wish to park their funds for 1 to 9 months. Short maturity funds begin from 1 year and go up to 3 or 4 years. Coming to the returns, it has been generally observed that liquidity products would start at about 6% or 7%, while the short majority funds go up to 8% or so.

Is liquid fund safe?

Liquid funds are open-ended schemes, where money is into debt as well as money market instruments, with maximum maturity of up to 91 days. This strategy helps to mitigate risk from interest rate volatility, generate stable income and provide high liquidity to portfolio.

What is a liquid fund in a mutual fund?

Liquid funds are a category of mutual funds where funds are invested in short-term market instruments like treasury bills, commercial papers, government securities and certificate of deposits. They are invested in securities with a maturity of up to 91 days, allowing investors to park their money for short periods, like 1 to 3 months. Liquid funds are a suitable option for those investors who have excess cash and think they might need it in a few days or weeks or months.

What are liquid and liquid plus funds?

The debt instruments in case of liquid plus funds have a longer tenure compared with that of liquid funds. The portfolios of liquid plus funds come with a higher average maturity. Investors in liquid funds can park their money for as less as one day, while the holding period for liquid plus funds need to be higher than that.

Leave a rating!
4.8 (4 votes)