What are Liquid Funds?

In today’s era investing is a very important part of personal finance. Due to this, there are a number of investing options available but they come with some amount of risk. A liquid fund is one of those numerous investment options, very few people know about it.

In this article, we will try to understand what is liquid Funds? What is the risk it involves? And also the most important part is What are the best liquid funds to invest in? 

So without any further delay let’s get started.

What are Liquid funds?

Liquid Funds are a kind of debt Funds that invest in fixed-income securities that mature in 91 days. These fixed-income instruments include Commercial paper, Government securities, treasury bills, Debt securities, etc. The liquid funds don’t have any lock-in period like mutual funds, your withdrawal requests are processed within 24 hours on business days.

Liquid funds are considered to be the least among all kinds of debt funds Since they mostly invest in high-quality fixed-income instruments that mature within 91 days. Therefore liquid funds are the best investment option for low-risk profile investors. 

How do Liquid funds Work?

Mostly the Liquid Funds work similarly to Mutual funds dose the only difference is Liquid funds don’t have any lock-in period and they only invest in fixed-income debt securities. The main objective of liquid funds is to provide their investors with Capital Protection and liquidity.

To do that fund manager selects high-quality debt securities whose maturity period is not more than 91 days and invests in them according to the scheme mandate. The fund manager tries to enhance the returns by matching the maturity of the individual securities with the maturity of the fund’s Portfolio. Generally, you will get more returns in a liquid fund compared to any regular saving account.

Factors to consider before investing in Liquid Funds:-

Some of the important factors that one should consider before investing in Liquid funds are as follows

1) Risk:-

As we had seen before Liquid Funds are the least risky among the classes of debt funds, but it is not risk-free it does involve some risk. Since the maturity of Liquid fund’s Portfolio ranges from 60 days to 91 days, they are not so volatile. Therefore the NAV of the Liquid Fund almost remains steady. The NAV can experience a drop if there is a decline in the credit rating of the Underlying Securities.

2) Expected returns:-

According to the past data, a good Liquid fund can provide you with returns ranging from 7% to 9%, which is much better than a regular savings account that gives you 4% interest. We should also consider the fact that returns in Liquid Funds are not guaranteed, but mostly Liquid Funds had delivered good returns to their investors.

3) Expense Ratio:-

Liquid Funds are just like mutual funds. Therefore like mutual funds, Liquid Funds also charge you an annual fee for the service they provide this fee is known as the expense ratio. Generally, investors do prefer the funds with a low expense ratio which helps them Maximize their returns. The Security and Exchange Board of India (SEBI) has mandated that the expense ratio should be below 2.25%. 

Mostly the fund managers of Liquid funds invest and hold the securities until maturity. Due to this fund does not face expenses arising from excessive buying and selling of securities which keeps the expense ratio low.

4) Investment Plan:-

Liquid Funds are the investment option for you if you want to invest your surplus cash for short period like 3 months. If you are planning to stay invested for up to one year then you should go with ultra-short funds to get higher returns.

You can also use Liquid funds to create an emergency fund. Since it provides you with higher returns and is as Liquid as a saving account.  

Advantages of Liquid funds:-

Some of the most significant advantages of liquid funds are listed below:

1) Low cost:-

As we had discussed before the expense ratio of the Liquid Funds is on the lower side. So that you can earn some higher returns. 

2) Low Risk involved:-

As mentioned earlier Liquid funds are the least risky amongst the classes of debt funds since the maturity period of the underlying securities is within 91 days.

3) Fast Processing:-

In Liquid Funds, the redemption request is processed within 24 hours on working days. Some of the liquid Funds also provide the facility of instant redemption.

4) Flexibility:-

Like open-end mutual funds, Liquid Funds don’t have any lockin period you can redeem your unit at any point in time. However, you have to pay a small charge in the form of exit load if you exit within seven days from the date of allotment.

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Taxability of Liquid Funds:-

If the Liquid fund provides you dividends, then it will be added to your income and taxed as per the income tax slab you fall under. If you Redeem your investment within three years then this will be considered a short-term capital gain which will be added to your income and taxed as per the income tax slab you fall in. If you Redeem your investment after three years it will be considered a long-term capital gain on which you have to pay 20% tax.

Top 10 Liquid Funds to invest in 2022:-

Conclusion:-

I hope, I had successfully given you the knowledge you were looking for about Liquid Funds. According to me, Liquid Funds are a very good option to invest in since you can create an emergency fund using them instead of keeping cash in your savings account. As mentioned earlier Liquid Funds are the least risky but they are not risk-free so think carefully before investing in Liquid Funds. If you have any doubt or want me to cover some more related topics then feel free to comment below. Happy Investing.

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