What are Liquid Funds?
Liquid funds are Open-ended debt mutual fund schemes that invest in short term securities like treasury bills, certificate of deposits, commercial papers and corporate fixed deposit.
These funds invest in Money market securities that have a residual maturity of less than or equal to 91 days. This helps to fund managers in meeting the redemption demand from the investors.
There’s more; these funds give an opportunity to earn a higher return than other traditional investment option like Saving bank account or fixed deposit, with high liquidity you enjoy on your saving bank account. And also, liquid funds carries a low levels of risk along with giving you a chance to earn an excess return (it may go up to 6-7%) as compared to saving bank account.
Therefore, being a low-risk mutual fund in the debt category, those individuals having idle money in their bank account can opt for Liquid funds as an alternative option.
How does Nav(Net asset value) calculate in Liquid Mutual funds?
NAV of these money market funds computed for 365 days, unlike other debt mutual funds where Nav calculated based on business days.
With other debt funds for purchase applications received within the cut-off time (3.00 P. M) having the value up to Rs.2 lakhs, the NAV as at the end of the day of the application applied. For applications of more than Rs.2 lakhs, within the cut-off time (i.e. 3.00 P.M.) the allotment of units is subject to realization of funds.
However, with liquid funds, for all transactions (irrespective of the value of the investment) received within the cut-off time (i.e. up to 2.00 P.M.) where money also realized within the cut-off time, the units allocated as per previous day NAV.
Let me give you an example:
Let us say if you invest in liquid mutual fund and transaction is submitted on Monday before 2:00 p.m and amount also realized by 2:00 p.m on Monday for the same transaction, then you will receive for Sunday’s NAV.
Similarly, when you do redemption request, and that submitted before the cut-off on Friday, then applicable NAV for redemption you will get for Sunday i.e the day before the next business day.
This means, your investments generate returns for every single day of investment, even if it is holiday or Sunday. This is called as Weekend parking in Corporates.
Who should Invest in Liquid funds?
Liquid funds are suitable for those investors who are looking for saving bank account alternative. Since these funds invest in high rated government securities and company deposits for short term.
Therefore, it does not carry a risk of default and volatility on the invested amount.
Let’s assume if you would like to park the surplus money you have received by selling residential property. This money you would like to utilize for other residential property in the near future.
If you are thinking about parking this amount into saving bank account. Then, you will receive a merely 3-4% rate of interest. And also, this interest income will be added to your income tax slab and will be taxed accordingly. What if you get a chance to earn better return along with the same feature of saving bank account like liquidity. That’s where liquid fund comes into the picture.
That’s because — you can invest in liquid funds for short term period, giving you a chance to earn at least 6-7% approx return.
And the best part, you can redeem it anytime without paying any penalty or exit load.
Furthermore, if you want to create an Emergency fund, then most often investor think of saving bank account.
However, saving bank account is not an ideal place to keep your emergency fund. This is because when you need money for other discretionary expenses, at first, you dip into those savings which are lying idle in your saving bank account. Hence, you can park your emergency corpus in Liquid funds.
Things to consider before investing in Liquid funds
While liquid funds are the ideal option to park your emergency corpus, you should pick the liquid fund schemes based on the following consideration:-
Fund Size: when do you think of investing in liquid funds, you should look at the fund size before zeroing on any scheme. It is highly recommended to invest in a fund which has at least 5000 crore asset size. Big size fund does not feel pressure for redemption, and that provides a freedom to keep invested with securities till their maturity period.
Return expectation: If you are looking for a higher return than your saving bank account, then liquid funds are a good option. Historically, these fund has delivered a return of 6-7% per annum. It was higher than your saving bank account wherein you may not expect more than a 4% rate of interest. However, there is no guarantee in the future for returns in liquid funds. But as per the Past track records of the best liquid funds delivered positive returns.
Investment horizon: Liquid funds are considered for short term period up to 3 months.
Let me give you an example; If you are planning to buy a home in the next 3-4 months, and accumulated your home down payment which is lying in your saving bank account. This accumulated amount can be park in the liquid fund for a short period as you can’t take the risk on that amount.
Hence, if your investment horizon is for short term, say, 3-6 months, and you can not take any risk, then you may go for liquid funds. Otherwise, if you want to invest for more than 9 months then ultra short term bond fund can be a good bet.
Investment cost: Another, the important parameter you should look at while selecting the liquid funds that are good for you i.e Investment cost. This is called as an Expense Ratio. You should choose a liquid fund which does not much cost you higher in your hand. Simply put, an Expense ratio is the fund management fee which is charged on your mutual fund scheme every year till you stay invested with the fund. It includes fund manager salary, administrative expenses, operating expenses, etc. Hence, it should be low as much as possible.
Know your financial goals: Liquid funds can prove to be useful for short term financial goals. And also, if you want to invest for Emergency corpus then the liquid fund is a better option as compared to Saving bank account. That’s because you get a chance to earn a higher return along with giving you an option for instant withdrawal (Some liquid fund schemes provides instant withdrawal facility)
Tax implication on Liquid funds
Liquid fund is one of the categories in debt mutual fund so you enjoy the indexation benefits after 3 years. However, if you redeem your liquid fund before 3 years, then capital gains generated will be considered as short term capital gains. In debt fund, short term capital gain will be taxed as per your income tax slab.
Here’s are the calculation for Indexation benefits:
Indexation benefit after 3 years
After three years of investments, a long-term capital gains tax is levied on debt funds at 20% with indexation. Indexation is adjusting investments for inflation for the holding period. The longer the hold period, the higher the benefit of indexation.
Let’s assume, 3 years ago, say on 20th January 2014, a person invested Rs. 1,00,000 in liquid funds, when he redeemed on 20th January 2017 (after three years) he got Rs. 1,27,729. His total gain was Rs. 27,729 but after adjusting for indexation (adjusting for the inflation during the investment period; 2014-15 CII was 852 and 2016-17 CII was 1081), his taxable gain was only Rs. 851 (1,27,729-100,000*1081/852), then investor need to pay tax only (851*20%)=170 Rs.
The indexation benefit is not available on saving account, FDs and RDs, it is only available on debt mutual funds if the holding period is more than 3 years.
In summation, these funds are a good substitute to regular saving account.
since the liquidity is high, giving more returns than regular saving account and have taxation benefits. Therefore, investors can invest their emergency funds in liquid funds.
If you choose dividend option in a liquid fund
Dividends received under liquid plans are not taxed at the hands of resident individual investors, but fund houses pay dividend distribution tax @28.325 percent (including surcharge and cess).
But after Budget 2018 DDT on all non-equity funds such as money market, liquid, and debt funds are 25 percent plus 12 percent surcharge plus 3 percent cess, totalling to 28.84 percent.
Another Reading:- Top 10 Dividend paying Mutual funds to invest in 2018
Liquid funds for Instant Redemption
Some Liquid fund provides the instant redemption facility, which is allowed upto 50,000 or 90% of the available balance for an investor.
The below are few liquid fund schemes that provide instant withdrawal facility
- Reliance Liquid funds
- Dsp Blackrock liquidity fund
- ICICI Prudential Liquid fund
And the best part, there are some apps available wherein you can redeem your liquid fund instantly with a single tap on your mobile screen. You don’t need to visit an AMC office. With ETMoney “Smartdeposit” you can invest in a liquid fund with your mobile device and redeem it anytime, anywhere with a single Tap. Even on public holiday or Sunday, you have full access to your money. Redemption gets credited into your saving bank account within 5 minutes.
Why Liquid funds are better than Saving bank account?
Most often, saving bank account will be a preferred option for the investor while parking surplus funds. Even though, if you are creating an Emergency corpus which you may require at the time of contingency, one cannot think beyond the saving bank account.
However, leaving your short term fund in a saving bank account is not a wise decision for the investors.
That’s because —
- Your money that lies in a savings bank account fetches you 4% interest per annum. Few banks offer a slightly higher interest rate of 6%. However, the best liquid funds have delivered return around 7% on an average in the past 1-year period. On returns alone, liquid funds score over a savings bank account.
- Liquid mutual funds have no lock-in period. Also, the withdrawals are processed instantly, and investors receive the amount within half an hour in most of the liquid funds.
- In liquid funds, the long-term capital gains (more than 3 years) are taxed at 20% after indexation, while short term capital gains are added to your income and taxed at the normal rate applicable to you. While in saving bank account, whatever interest income you earn will be added into your income and taxed as per the Income tax slab, there are no indexation benefits.
- liquid funds do not have any entry or exit loads.
- Liquid funds have the lowest interest rate risk among debt funds as they primarily invest in fixed income securities with a short maturity period.
10 Best Liquid funds should consider investing in 2019
Here are best performing liquid funds that have delivered consistent 6-7% yearly returns in multiple periods of time with ease.