Liquid Mutual Funds = Stable returns + high liquidity + low risk
About 95% of Indian households prefer to deposit their money in savings bank account while less than 10% choose to invest in mutual funds or stocks according to the latest Securities and Exchange Board of India (Sebi) investor survey. Assured returns and instant liquidity attract investors to bank accounts. While they can keep a portion of their money in savings accounts based on their comfort level, they can consider investing in liquid funds which also offer quick liquidity with stable returns
What are liquid mutual funds?
A liquid fund is an open-ended mutual fund scheme whose investment universe comprises certificates of deposit (CDs), commercial papers (CPs) and government treasury bills (T-bills) with maturities of up to 91 days. Maturity is mostly lower than that. The prime objective of these funds is to seek optimal returns while maintaining safety and high liquidity.
Other key features:
Liquidity in a day’s notice and no entry & exit loads – Instant liquidity associated with savings bank account lure investors. Liquid funds also offer instant redemption. However, capital market regulator Sebi has put a limit of Rs 50,000 or 90% of folio value, whichever is lower, on such redemptions. Prior to the new regulation, investors had to wait for a day to get their redemption money. For instance, the cut-off time on withdrawal from a liquid fund is generally 2 p.m. on business days. So, if an investor places a redemption request by 2 p.m. on a business day, funds will be credited to his/her bank account normally on the next business day by 10 a.m. Further, most liquid funds have no entry and exit loads which brings additional relief to investors.
Least risky among all debt funds – Liquid funds are not risk-free but are least risky among all debt funds as they invest in money market instruments with very low maturity. Liquid funds reduce the risk by investing in high rated papers, thus building a safety net. An analysis of CRISIL ranked liquid funds showed these funds, on average, held 79% of their portfolio in top rated money market instruments (A1+) in the year ended March 31, 2017. Before investing, investors should do due diligence about the portfolio attributes.
Liquid funds vs traditional investment avenues such as the savings account
Better yielding – In spite of deregulation of interest rates by the Reserve Bank of India (RBI) in 2011, most banks offer 4% on savings deposits. Though some banks offer higher interest rates, they require higher minimum deposit amount. In comparison, liquid funds offer relatively higher returns. Liquid funds, exemplified by CRISIL – AMFI Liquid Fund Performance Index, returned 7.26% in the one year ended April 30, 2017 (average one-year daily rolling returns). These funds have scored over savings account in terms of both rolling one-year returns and point-to-point returns.
Post-tax returns of liquid funds are better
Liquid funds provide higher post-tax returns even though there is a tax benefit of Rs 10,000/- on savings bank account interest (for individual & HUF). Further, in case, the investor holds money in liquid funds for more than 3-years, they are also liable to get indexation benefit, which can further reduce tax liability to the investor based on the prevalent inflation scenario.
Liquid funds are ideal for investors with a low risk-bearing capacity and short-term investment horizon. However, investors should note that returns of liquid funds are linked to the prevailing money market yield and they do not guarantee the principal amount invested and returns, unlike savings account. Hence, investors need to choose the fund wisely in line with their risk appetite, returns, and liquid expectations.