What Is A Liquid Fund?
Many a times, we come into possession of surplus funds which must be invested. But fixed deposits are not an option as they have a lock in period which cuts off access to the cash. In such a situation, a liquid fund can become one of the most beneficial investment options. Unlike savings deposits which provide only minimal interest, liquid funds will allow you to earn better interest on your invested capital.
In investment terms, the term ‘liquid’ refers to something which is as mobile as hard cash. For instance, real estate is the least ‘liquid’ of assets, while a savings deposit is one of the most ‘liquid’ assets. Hence, liquid funds are a type of mutual fund / debt fund whose redemption period is less than 24 hours. These funds make investments mainly in money market instruments like commercial papers, certificate of deposits, term deposits and treasury bills.
The lock-in period of liquid funds can go up to a maximum of 3 days while the encashment of the proceeds takes place within 24 hours. Some liquid funds may have a lock-in period of up to a week or even a month.
One of the characteristic features of liquid funds is that the underlying assets of the fund have a lower maturity period which can be helpful for the fund manager in times when redemption demands have to be met.
Is Income From Liquid Funds Taxable?
Capital gains from liquid funds are subject to tax. In case the funds are sold within three years (36 months), they will attract short-term capital gains tax. The rate of tax will be determined based on the income tax slab under which the individual falls. In case the funds are sold after three years, they will be subject to long-term capital gains tax which will be levied at 20% with the benefit of indexation.
Features of Liquid Funds
- They feature a low annual fee between the range of 0.30% to 0.70%.
- The minimum investment for liquid funds will vary with different schemes.
- No entry and exit load.
Benefits of liquid funds
- No Lock-in Period - They are known as liquid funds as they have no lock-in period and give you quick access to the cash by redemption.
- Quick Withdrawals – Liquid fund withdrawals take place in a very short time, usually within a span of 24 hours.
- Lowest Interest Rate Risk – Given that liquid funds mainly invest in fixed income securities which have a short maturity period, they have one of the lowest interest rate risk as compared to other debt funds.
- Tax Benefits - Liquid Funds offer valuable tax benefits.
- Comparatively Good Returns – Liquid funds offer an average return of about 8% per annum.
Risks and Returns Associated with Liquid Funds
All the investments made in liquid funds, similar to investments in other mutual funds, are made in securities which come with a market price. The NAV (Net Asset Value) of your mutual funds increase or decrease based on the securities’ market price. However, the NAV of a liquid fund doesn’t increase or decrease as drastically as other funds.
According to SEBI (Securities and Exchange Board of India), in case a security matures within 60 days, it does not have to be marked to market. Only the interest component will have to be added. Basically, the amount of interest earned by the debt fund via a security’s tenure will equally divide the overall interest component for the number of days the security is held. The price of the security shall stay steady. Therefore, the movement of the NAV of the liquid fund will be linear. This does not mean that the liquid funds are free of risk.
The fund can make investments in scrips with maturity periods of up to 91 days. Thus, if investments are made in scrips with maturity periods ranging from 60 to 91 days, they will have to be marked to market based on their credit rating. In case there are defaults by underlying companies on the principal and/or interest repayment, the credit rating of the scrip will decline along with its market price. In case investments from your liquid fund have been made in such securities, the NAV of the fund will decline too.
What is so special about liquid funds?
Liquid funds usually take just one day to process the encashment of funds. Thanks to the advancement in technology, however, you can soon get all your money in just a few minutes. However, the limit on the amount you can take out has been set at 90% of the value of your portfolio, or Rs.50,000 per day, whichever is less.
Liquid Fund Plans Available
Different plans like monthly dividend plans, weekly dividend plans, daily dividend plans and growth plans offer liquid funds. Investors are free to chose a plan as per their financial needs in term of convenience and liquidity. Retail investors are also free to invest in direct plan which feature a lower expense ratio. This helps yield higher returns.Disclaimer
Mutual Fund investments will be subject to market risks. Any mutual fund listed in the document does not guarantee fund performance or its underlying creditworthiness. Do read the mutual fund document thoroughly before investing. Specific investment needs and other factors have to be taken into account while designing a mutual fund portfolio.
GST rate of 18% applicable for all financial services effective July 1, 2017.