Tags: Wealth Management, Investment Lesson, Mutual Funds, Stock market, Budget, Finance, Investing, Personal Finance, Investment, Liquid Funds
It is advisable to maintain a contingency fund for any future emergencies. The quantum of such a contingency fund is relative to different individuals depending on their committed payments, lifestyle expenses, etc.
However, as a generic measure, one should maintain a contingency fund equivalent to cover expenses for the current lifestyle for at least six months to have a sufficient financial cushion. Most people park their emergency funds in savings accounts because of liquidity and nil market-linked risks, however, they may offer interest as low as less than 3%.
Liquid funds on the contrary, may yield better reasonable returns as they invest primarily in debt and money market instruments of up to 91 days residual maturity. Since the investments are in short-term papers, interest rate risks are much lesser in these funds. They also offer reasonably good liquidity and convenience, making them a preferred alternative for parking surplus funds.
Understanding Liquid Funds - What are liquid funds?
Liquid funds are a category of debt funds that invest primarily in debt and money market securities with a maturity of up to 91 days only. Accordingly, such funds may invest in Treasury Bills (T-Bills), Commercial Papers, Certificate of Deposits, Government Securities having residual maturity of up to 91 days, etc.
Liquid funds derive their nomenclature due to the liquidity offered to the investors, as the redemption for liquid fund units is processed faster than in other mutual fund schemes. Any redemption request placed before the cut-off time on a business day is processed for credit to the investor's bank account on the next working day. Presently, the cut-off time for redemption requests of liquid funds to be processed on the same day is 1.30 PM. Therefore, you need to place a redemption request before 1.30 PM on a working day to receive the redemption proceeds in the registered bank account on the following working day.
Benefits of liquid funds
Potential for better returns
Liquid fund investments are in debt and money market instruments and may offer reasonably good returns. Professional fund management for the invested money can further equip the investors with the potential for better returns.
No exit load for an investment of seven days or more
If the investor has invested in liquid funds for seven days or more, no exit load is levied on the redemption. For investments with a holding period of fewer than seven days, a graded exit load is charged, which reduces as the holding period increases and becomes zero on the seventh day of holding investments.
Liquidity
Liquid funds are named so on account of the liquidity of the invested funds, as the redemption requests from liquid funds are processed faster than regular equity or debt funds. Any redemption request placed before the cut-off time on a working day is processed for redemption credit to your bank account on the next working day.
Low risk
Considering that the residual maturity of the portfolio securities is up to 91 days only, there is a minimal impact of interest rate movements. As such, liquid funds carry insignificant interest rate risk.
Given the convenience of investing in liquid funds, liquid funds occupy the lion's share of open-ended debt funds' overall AUM (Assets Under Management). Liquid funds represent around 30% of the total assets of open-ended debt funds and 10% of all the mutual fund schemes with an AUM of Rs. 3.64 lakh crore as of June 30, 2022.
Source: Association of Mutual Funds in India – AMFI
However, a significant chunk of this AUM comes from institutional and corporate investors, which use liquid funds to park their short-term surplus funds.
Factors to Consider When Choosing Liquid Funds
Since liquid funds invest in short-term debt and money market instruments, the returns of these funds tend to follow prevailing market policy rates. As a result, they are in line with the interest rate outlook at the short end of the curve.
Liquid funds have a graded exit load structure staggered over seven days, and no exit load is applicable if the holding period is seven days or more. However, if the investor needs to redeem investments before seven days, the transaction will be subject to exit load, which reduces as the holding period increases. Further, the potential of better returns from liquid funds tends to negate the exit load implications.
Looking for the best liquid funds? While most of the liquid funds would be largely similar, carrying similar investment objectives, here are some finer points on how to choose the liquid fund that matches most with your investment requirements:
Liquid fund returns
This is often the most generic yardstick to measure any fund's performance. Investors will always be inclined towards a fund consistently providing good returns. However, one should be slightly cautious if there has been significant outperformance of the fund against the fund category in recent times.
This might indicate the fund manager's aggressive investing style, wherein high yields may have been received with corresponding high risk. This may not be desirable for defensive mutual funds like liquid funds, primarily used for short-term investments by investors.
Liquid funds expense ratio
Since all the scheme expenses are charged directly to the mutual fund scheme, a relatively higher Total Expense Ratio (TER) from the other funds in the category may reduce the portfolio returns and impact the overall investor returns. As such, investors should look at the TER charged to the scheme before making an investment.
Liquid funds credit profile
Liquid funds invest in short-term debt and money market instruments having residual maturity of up to 91 days only. Hence, it is pertinent for these funds to invest in such liquid instruments, which can be easily withdrawn at any time. Debt & related instruments having higher credit ratings bear better inherent liquidity and have less credit risk. However, such funds may have a relatively higher exposure to lower-rated issuers, as they are higher-yielding but come with equally higher liquidity and credit risks. Therefore, investors should be cautious of the credit rating profile of the portfolio of the liquid fund before investing.
Liquid funds diversification
Portfolio diversification is one of the essential investment considerations for investors as it diversifies the risks. You should ensure that the fund's investment portfolio is suitably diversified and not concentrated with investments in a particular issuer group or sector. In addition, the correlation between the issuers/sectors in the portfolio should be less or negative. This will help reasonably diversify the risks of negative impact, arising due to unfavourable market situations for a certain issuer/sector.
How to invest in liquid funds?
The process to invest in liquid funds is not different from investing in other mutual fund schemes. Thus, the investors can invest in liquid funds by physically submitting the application forms at any Official Point of Acceptance (POA) for the mutual fund house or the Registrar & Transfer Agent (R&TA).
Further, an investor can also undertake the transaction through digital means, i.e., through the website/mobile app of the mutual fund house or R&TA. Such investment can be made in a lump sum or through a Systematic Investment Plan (SIP). If one has registered a SIP, the investment amount is deducted automatically from the bank account on a specified date and invested in the specified mutual fund scheme. As such, SIP enables investors to make regular and consistent investments.
Taxation of liquid funds
Similar to the treatment of returns from other debt funds, the realized returns from liquid funds are taxed as capital gains, wherein the tax rate depends on the investment holding period. Short-term capital gains (with an investment period of fewer than 36 months) are taxed at the regular tax rates (plus applicable cess and surcharge), while long-term capital gains (where the investment period is 36 months or more) are taxed at 20% (plus applicable cess and surcharge) with indexation benefits.
Indexation adjusts the acquisition cost for inflation prevailing over the investment period while calculating the taxable gains, thus taxing only inflation-adjusted returns. Given the low risk and similar liquidity with a potential for better returns, investors must consider parking their surplus or contingency funds in liquid funds.
Note: The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2022 presented in the Parliament in February 2022. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the investment date.
Disclaimer:
The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. All complaints regarding Mutual Fund can be directed towards visit www.scores.gov.in (SEBI SCORES portal). Readers are requested to make informed investment decisions and consult Chaitanya Financial Consultants – 9000628943 / mfd.mmr@gmail.com to determine the financial implications with respect to investing in Mutual Funds.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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