Liquid funds or liquid debt funds schemes mainly invest in highly liquid money markets and short-term debt instruments like treasury bills, certificates of deposit, commercial paper, etc. Still, as compared to savings accounts, it promises slightly better returns, and the invested money is available to the investor at short notice. In great reputation, in the liquid fund, we find the characteristic of high liquidity, as on a business day, the unit could be redeemed. An example includes parking for funds needed in case of emergency funds, funds for planned expenditures, or intermittently required funds. Compared to risk equity, liquid returns are lower but higher than those of a savings account. In this exhaustive guide, we shall familiarise ourselves with the meaning of liquid funds, the key characteristics of the product, how they work, who the investors should be, and how to select the ideal liquid fund scheme.
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What is Liquid Fund?
Liquid funds are the type of debt mutual funds that invest primarily in very high liquidity money markets and short-term fixed-income instruments. The maturity period of the instruments is from overnight to 91 days. The instruments can be commercial paper, certificates of deposit, treasury bills, repo, triparty repo, government securities with under 91 days maturity, etc. As they are open-ended schemes, there is no lock-in; hence, daily subscriptions and redemptions are allowed. Portfolio maturity is kept under 60 days. The main aim of liquid funds is to provide returns that are more than those of a savings account and yet be highly liquid. Involving less risk when compared to equity funds, it nonetheless earns more than the bank fixed deposits. Liquid funds suit those wanting to park short-term surplus funds.
Key Features of Liquid Funds
Here are some of the key features of liquid funds:
High Liquidity
Liquid funds have high liquidity as customers can redeem units on any business day. Fund houses dispatch redemption proceeds within one business day, making them suitable for parking funds needed to meet short-term and emergency needs.
Lower Risk
Liquid funds invest in high-quality debt and money market instruments below 91 days’ maturities, which makes them less risky than long-term debt and equity funds. They are subject to low-interest rate risk. Credit risk is also low, as per SEBI guidelines at least 20% must be invested in government securities.
Stable Returns
Liquid funds provide relatively stable returns at around 7-8% annually compared to the returns of a savings bank account at 3-4% annually. In other words, the return is moderately higher for liquid funds than for savings banks. Returns are stable, as short-term interest rates do not fluctuate much.
Convenience
Lastly, another added clause would be that investing in liquid funds is convenient through online access, mobile apps, ECS mandates, instant redemption, etc. Additional purchases or redemptions can be made at any time.
Transparency
The composition of the portfolio and the NAV of the fund are declared on a daily basis for Liquid funds. Quality of credit and returns are open for the investors to pursue.
Tax Efficient
One of the significant advantages of the fund is the indexation benefit in case of long-term capital gains on holding for more than 3 years, which makes it highly tax efficient. Dividends from the liquid funds are tax-free in the hands of the investors.
Suitable for parking short-term funds: Liquid funds facilitate the park surplus funds for shorter durations to earn better returns as compared to keeping them idle in a savings account. Being high liquid, it is most suitable for the same.
How Liquid Funds Work
Liquid funds work in the following manner:
The fund manager invests across highly liquid money markets and short-term debt instruments across the board, which include treasury bills, commercial paper, certificates of deposit, repo, triparty repo, etc. The focus is on the instruments with maturity in under 91 days.
The fund manager actively manages the portfolio based on the level of interest rates and the quality of the credits for the instruments. The goal is to maximise the returns and, at the same time, maintain its safety and liquidity.
The value of the fund’s NAV or value changes daily, generally with both interest accruals and mark-to-market re of the portfolio. When interest rates drop, bond prices increase, causing NAV appreciation.
The working of these Liquid Funds includes purchasing or depositing units on any business day at an NAV based on the day’s transactions. Fund houses process redemptions within one business day.
Liquid funds will pay dividends subject to the availability of distributable surplus. Divid dividends are paid periodically or can be reinvested into the fund.
The fund managers always keep the liquidity very carefully to manage the daily inflow and outflow. The portfolio maturity is restricted to up to 60 days.
Who can invest in Liquid Funds?
Below are the investors’ profiles suitable for the liquid funds:
- Individuals: Liquid funds make an ideal parking place for emergency funds, intermittent expenses, or funds needed for planned expenses in the short term. High liquidity reflects easy redemption at any time.
- Salaried Professionals: Monthly income surplus can be put in liquid funds for this category and be redeemed periodically for expenses. These give better returns than savings accounts.
- Traders & Businesses: For traders and businesses, liquid funds give a higher return and increase their income by parking working capital and surplus cash instead of in current accounts.
- Retirees: Parking of redemptions of other investments to meet the need for liquidity before reinvestment.
- Institutional Investors: Parking of short-term surplus funds can be done in liquid schemes to benefit from higher returns for corporations, banks, and institutional investors.
- NRIs: Liquid funds enable NRIs to keep their funds for a short period and enable them to earn at a higher savings rate vis-à-vis NRE/FCNR accounts. In addition, funds can be easily repatriated effectively.
- Students: students studying abroad can park family funds in liquid funds and redeem them periodically for expenses. This ensures funds earn better returns.
How to Select the Right Liquid Fund?
Some of the tips for selecting and investing in the ideal liquid fund are
Analyse Historical Returns:
Compare the returns of liquid fund schemes for 1-year and 3-year returns. Look for a fund having steady and consistent returns over the period.
Review Credit Profile:
- Check the portfolio credit quality
- Funds with high exposure to sovereign and AAA-rated instruments are safer.
- Avoid funds with high exposure to risky assets.
Portfolio Maturity Check:
Lesser portfolio maturity indicates higher liquidity. Choose funds with an average maturity maintained under 60 days.
Liquidity Position Evaluation:
Study of cash or cash equivalent allocation that helps to evaluate the liquidity level to meet the redemption requirements of the fund.
Choose Fund House Carefully:
Go for liquid funds of reputed AMCs with solid credit risk assessment processes. Avoid newer or lesser-known AMCs.
Check Expense Ratio:
A lower expense ratio implies more money for investors. Compare expense ratios before investing.
Experience of Fund Managers:
The experienced fund manager will have a better negotiation with him in every change related to interest rates and liquidity management.
Ensure Easy Access:
Access to the online and mobile app makes it handy to monitor, invest, and redeem money. Choose the fund that offers convenient online services.
How to Invest in Liquid Funds?
To invest in a liquid mutual fund, follow these steps:
- Select a liquid fund plan and fund house: Go with a reputable AMC such as HDFC, ICICI, SBI, and so on. Examine and narrow down a top-performing liquid fund plan according to factors including fees, credit quality, and returns.
- Finish the KYC procedure: Submit the necessary paperwork, such as your passport, PAN card, and Aadhaar, to finish the KYC process. This procedure is done just once.
- Create an investment account: You may open an online or offline mutual fund investment account with the company that handles funds. Fill out the application with your KYC information.
- Make an investment decision: Decide whether you wish to begin a systematic investment plan (SIP) in the liquid fund or make a lump sum investment. If necessary, choose the auto redemption options.
- Fund transfers: In the event of an SIP, you may use net banking, UPI, bank transfers, check deposits or debit mandates to move the investment amount to the liquid fund.
- Obtain account statement: Upon successful unit allocation, you will receive a confirmation statement. You can see the units in your investing account.
- Monitor performance: To see the daily NAV and portfolio holdings, log in to your investment account via the internet or a mobile app. Get transaction notifications via SMS.
- Redeem funds: Depending on your liquidity requirements, you may redeem units any day by submitting a redemption request online or in paper form. Within a day, the funds are credited to your bank account.
The essential actions to begin investing in liquid mutual funds are covered above. Make sure to keep an eye on your investments, maximise profits, and have enough cash.
Conclusion
Liquid funds are an ideal avenue for the investor to park his short-term surplus funds and earn relatively higher returns while maintaining easy liquidity. In these funds, an investor is provided with a prospect of stable returns coupled with a low level of risk and a high level of convenience. Liquid funds are ideal for individuals, salaried professionals, businesses, and institutional investors who need a productive parking place for temporary surpluses. However, one has to carefully choose the right liquid fund after analysing returns consistency, credit profile, liquidity position, and fund manager’s experience. Overall, liquid funds deliver a balanced safety, returns, and liquidity proposition.