Liquid Mutual Funds: Features, Benefits, Taxation And How To Invest

Mutual funds

Liquid funds are mutual fund schemes that invest in money markets and debt instruments. It is an efficient financial tool to invest money for a short tenure extending to a few months or weeks. An investor can withdraw his/her money from these funds at any time and can get accrual for every day of investing. 

If are planning to invest in liquid mutual funds, check how they work, their benefits, how to select the best liquid mutual fund and the returns and risks associated with liquid funds. Read on!

What Are Liquid Mutual Funds?

Liquid mutual funds are debt funds that invest in fixed-income securities like treasury bills, commercial papers, government securities, bank term deposits and certificates of deposits. The maximum maturity period for these schemes can be up to 91 days. Unlike other mutual funds, a liquid debt fund calculates its NAV (Net Asset Value) for 365 days. These schemes carry one of the lowest interest rate risks under the debt fund category. 

How do Liquid Mutual Funds Work?

Liquid mutual funds invest in money market capitals and commercial papers and is a debt mutual fund. Liquid mutual funds have no lock-in period and the maturity period is 91 days. Liquid mutual funds can only invest in the listed commercial papers and 20% of the assets should be liquid investments such as money market securities. Liquid mutual funds mainly earn through the interest payments on the debt instruments and have less significant capital gains and losses. The interest rates and the bond prices are inversely proportional. Hence when the interest rates fall the bond prices go up and vice versa. This is the most viable choice for short-term investments. 

Features of Liquid Mutual Funds

Liquid mutual funds have the following features which make them a good short term investment option:

• Liquidity: Liquid mutual funds invest in cash instruments and have a short maturity period which makes it easier for investors with the need for early withdrawal.
• No entry or exit load: Liquid funds do not have any entry or exit load as it has high liquidity and a short term maturity period.
• Return on investment: Liquid mutual funds usually provide an 8% return on investment which is higher than any other fixed savings instruments. RBI increases the interest rate as inflation rises and liquid funds provide high returns during such time.
• Annual charges: Liquid funds have low annual charges such as 0.30% to 0.70%.
• Interest rate risk: Liquid funds have lower interest rate risk due to investment in fixed income securities and short maturity period.
• Various options: There are various investment options to choose from in liquid funds such as daily dividend plans, monthly dividend plans, weekly dividend plans and growth plans.

Benefits of Liquid Funds

Individuals interested in investing in liquid debt funds will want to know its advantages:

Short maturity period

Maturity periods can be between three days to three months at most. You can instantly liquidate your funds during an emergency. An individual can sell the fund units without paying an exit load. 

Safe investment

These liquid debt schemes invest in fixed income instruments like debentures and bonds. These have a fixed interest rate and short maturity tenure. These funds are less volatile and show favourable performance irrespective of the market situation. 

Instant redemption

Fund houses typically process the withdrawals of liquid fund investors within a day. That means an Asset Management Company (AMC) takes minimum time to settle the redemption amount of the investor.  

Efficient taxation

Investors find liquid debt funds a lucrative option because of the tax benefits available.

How to Select Best Liquid Mutual Funds?

While choosing the best liquid mutual fund, check the following three factors:

Credit Ratings: Liquid funds are high-risk and high-liquidity funds. It is important to check the credit ratings of the fund as they reflect your capital protection capacity. These ratings keep fluctuating depending on the market. So it is essential to check the rating regularly before investing.

Expense Ratio: Mutual funds are mostly actively managed by the fund managers. Hence, the expense ratio is higher. But in liquid mutual funds fund managers have little to do so it is expected that the expense ratio will be lower than that of other types of mutual funds such as equity funds.

AUM: As opposed to what is generally advised by experts, liquid mutual funds with large AUM (Assets Under Management) will be a good choice. There must be doubts as to why liquid funds are so different that it goes against all the rules of any other mutual fund! Well, liquid mutual funds are short-term investments and have high liquidity right? Well, if the investors withdraw from funds then the managers will have to pull out money from the securities which will in return affect the returns. This is why you should choose liquid funds with large AUM so that they can handle the withdrawal pressure at the time of need.

What Are the Returns and Risks for Liquid Funds?

Like other mutual funds, liquid funds invest in securities with different market prices. The mutual fund’s NAV decreases or increases depending on the market price of underlying securities. However, a liquid debt fund’s NAV doesn’t decrease or increase as noticeably as other schemes. 

As per SEBI guidelines, security maturing within 60 days doesn’t need to be marked to the stock market. An AMC has to add the interest component only. A debt fund’s interest amount via its instruments depends on the total interest sum and the number of days it is held.

Hence, the instrument’s price will usually remain steady, and the liquid funds’ NAV will show linear movement. This does not denote that the liquid schemes are risk-free. 

Liquid funds invest in scrips having maturity periods of 91 days (maximum). So, investments in scrips with maturity tenures of 60-91 days are marked to market in accordance with their credit rating. However, if one/more underlying companies defaults on repayments, their credit rating, market price and NAV will decline.

Also Read: Fund Of Fund in Mutual Fund: 10 Best Fund Of Fund Schemes In India

Liquidity of Liquid Mutual Funds

Liquidity refers to the availability of your investment when you are in need. Liquid mutual funds have high liquidity as they have no lock-in period. A lower maturity period of 91 days also makes this mutual fund highly liquid and readily available to an investor in need.

Tax Implications of Liquid Mutual Funds

Liquid mutual funds involve the following tax implications:

• If the fund units are held for more than 36 months, the sale attracts long-term capital gains tax. The current tax rate is 20%. You will get the indexation benefit before taxation. 
• If you are selling the fund units within 36 months, you will attract short-term capital gains tax. The tax rate depends on the income tax slab of the investor.
• Dividends received on mutual funds above Rs. 5000 are taxable at a 10% rate.

Who Should Invest in Liquid Mutual Funds?

If an individual wants to make a short-term investment with lower risks, he/she can choose liquid debt schemes. Investors can utilise liquid debt funds as a stepping stone to invest in equity mutual funds. 

They can begin to invest in liquid funds and then register for a systematic transfer plan to invest in an equity fund. This enables them to invest in a phased manner and take advantage of Rupee Cost Averaging. 

If you are looking for a safe investment plan or to set aside money for emergencies, you may want to look for Navi Liquid Fund. You can initiate an investment in their direct plan at Rs. 500 only through platforms like Grow, Kuvera and Zerodha.     

What is the Right Time to Invest in Liquid Mutual Funds

You can start investing in liquid mutual funds right now! As liquid mutual funds have no lock-in period and short maturity period, it is advisable to stay invested as long as possible to reap the benefits of compounding. Visit Navi Mutual Fund to get started.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully. 

How to Invest in Liquid Mutual Funds?

You can invest in a liquid mutual fund in either direct or regular methods.

If you want to invest directly you can choose from either of the two options below:

• AMC (Asset Management Company)
• Investment platform

To invest in a regular way you have to do so through an intermediary or third party. For this, the expense ratio will be higher as the AMC has to pay a certain commission or brokerage fee to the intermediary.

To invest through an AMC or investment platform, you have to follow the given steps:

Step 1: Go to the website of the AMC or investment platform and log in to your account.

Step 2: Fill in your KYC details

Step 3: Compare and choose the liquid mutual fund if it is the right option for you.

Also Read: 10 Best Medium Duration Debt Funds

Things to Consider Before Investing in Liquid Mutual Funds

Liquid mutual funds are a good avenue for investment, which you must know by now. But you should consider the following factors while investing in liquid mutual funds:

Risk: Liquid funds have low volatility due to short maturity tenure but mutual funds are not risk-free. With a drop in any of the security, the NAV of the fund can drop too.

Expense ratio: Due to the almost low to the negligible role of a fund manager in managing a liquid fund, the expense ratio of these mutual funds is usually low.

Investment plan: These funds are good for short term investments with lower risk and volatility. The maximum tenure of maturity is up to 3 months. So if you are looking for a long term investment, it will be better for you to opt for a different mutual fund plan. Liquid mutual funds are good as an emergency fund.

Also Read: Everything About Gold Funds: Benefits, Risks Involved and More

Final Word 

Many investors use liquid funds as emergency funds. These have as much liquidity as savings deposits and offer favourable returns at low risk. Investors desiring a 3 month-investment horizon can choose these funds. Before investing, you can create an effective investment plan.

FAQs on Liquid Funds 

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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.