Finance

A comprehensive guide to understanding liquid funds   

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Investing money is always a wise decision but choosing the right investment instrument is crucial to make your money grow.

Many people prefer investments with a high level of liquidity, that is the ability to quickly and easily convert an asset into cash. This preference for liquidity can come from the need for flexibility and accessibility in unforeseen situations where you suddenly require money for an emergency, unexpected bills, or a sudden job loss. In such scenarios, having your funds tied up in a long-term investment can create inconvenience and stress. This is where liquid mutual funds come in.

How do liquid funds work?

Liquid mutual funds invest in short-term debt and money market instruments such as treasury bills, commercial papers, and certificates of deposit that mature within 91 days. These fixed-income securities have a low level of risk and offer stability compared to investing in stocks or other mutual funds.

By investing in highly rated short term debt securities, the fund manager aims to keep the portfolio safe while allowing the investments to be liquidated easily.

Taxation of liquid fund investments

As per the proposed changes in the finance bill 2023, starting April 1, 2023, debt mutual funds that invest less than 35% of their assets in equities will be taxed as per an individual’s income tax rates, irrespective of the holding period. So, liquid funds, being a category of debt funds, may be taxed similarly as per your tax slab.

Why to add liquid funds to your portfolio?

Liquid funds have a lower risk profile as they have extremely short maturity periods making, them less sensitive to credit default risk and interest rate risk. As such, investors who want to earn a better return than a savings account without taking on excessive risk can add these funds to their portfolios.

Liquid funds offer high liquidity, meaning that they can be easily bought and sold, and redemptions of up to Rs 50,000 are processed and credited within a day through an instant access facility. This makes them an ideal option for investors who have excess cash, which they may need on short notice.

These mutual fund schemes also offer the potential to earn better returns than traditional bank deposits while preserving the safety of capital, which is crucial to most investors.

How to invest in liquid funds?

Investing in liquid funds is fast and easy through various digital platforms and mutual fund investment apps. To invest offline, simply visit a mutual fund’s branch office or contact registrar and transfer agents (RTAs).

You can even start an SIP in liquid funds to invest a fixed amount at regular intervals, helping you adopt a disciplined investment approach. Make sure to use an SIP calculator beforehand to project the estimated returns, compare different SIP plans, and set an investment amount that fits your budget and aligns with your financial goals.

Things to note before investing in liquid mutual funds in India

While liquid funds can offer positive returns with relative safety, it is important to note that they are not entirely risk-free. Market fluctuations, interest rate risks, and credit risks can impact the fund’s returns. So, carefully evaluate the fund’s past performance, its size, investment strategy, portfolio diversification, expense ratio, fund manager’s experience, and follow risk management practices.

If feasible, consult a financial advisor who can help you create a portfolio that considers your current finances, goals, risk appetite, and other relevant factors.

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