Liquid mutual funds are a type of debt funds that invest in short term fixed interest generating money market instruments, treasury bills, commercial paper, these are some examples of the underlying securities in the portfolio of a liquid fund.
The main objective of liquid funds is to provide a high degree of liquidity and safety for investors hence the term liquid fund. For this purpose, the fund manager invests only in high quality debt instruments that mature in just 91 days. The allocated percentages are as per the scheme’s investment objective. The liquid fund portfolio manager will try to ensure that the average maturity of the portfolio is just three months, so that the funds value does not undergo a lot of fluctuations. The fund manager, while managing the liquid fund, also takes into account the stock market outlook based on interest rates and liquidity. This reduces the sensitivity of the fund returns to interest rate movements in the Indian economy and makes liquid funds more stable.
Liquid funds are an excellent option to park your idle money that you do not want to block in longer term investments such as bank fixed deposits or company fixed deposits, government bonds. These funds are ideal to invest surplus cash for a short period of upto three months. Liquid funds are low-risk avenues which offer higher returns than a savings bank account. Liquid funds try to replicate the liquidity aspect of a savings bank account. These funds don’t have a lock-in period, hence investors can use liquid funds as a regular savings account and earn higher returns. Even though these funds offer the possibility to deliver only marginally higher returns than your saving bank account they are not suitable to build wealth over the long term.
While investing in liquid mutual funds there is always the possibility that the liquid funds value may fall suddenly on account of a downgrade of the credit rating of the underlying instrument, hence liquid funds are not entirely risk free. Liquid funds have generated profits in the range of 6% to 8% which is higher than the 4% returns offered by many savings bank accounts. Although the returns on liquid funds are never assured, in most cases, they have provided positive returns on redemption. In case you have a longer investment horizon, say of up to one year, then you may want to consider investing in ultra-short term mutual funds or other debt funds to get a comparatively superior return. Liquid funds are therefore your best bet for investment upto three months.
In a bank’s savings account, investments of up to Rs 5 lakh are covered under deposit insurance. There is no such insurance feature available with liquid funds. Therefore before you choose a liquid mutual fund, you might want to analyse the liquid fund from different viewpoints. There are several quantitative and qualitative measures used to select the best liquid funds to meet your risk profile and goals of this investment. Liquid funds have the same tax liability as a FD or your savings account.
The information, analysis and opinions expressed herein are for educational purposes only and are not intended to provide specific advice or recommendations for types of liquid mutual fund schemes. This material is not an offer, solicitation or recommendation to purchase any financial products or services or liquid mutual funds. Always remember that all investments, including liquid mutual fund investments carry some level of risk, including the potential loss of principal invested.