What are liquid funds and how to invest?

New investors might often wonder “What is liquid a fund?”. A liquid fund mutual fund invests in debt and money market securities with a maturity of up to 91 days only. They are considered to carry relatively low/ low to moderate risk and can offer a relatively better return potential than a regular savings bank account. Liquid funds are often utilised by investors to park their surplus funds for a short period.

• Table of contents

1. What is a liquid fund ?
2. Step-by-step process to invest in liquid funds
3. Benefits of investing in liquid fund s
4. Factors to consider before investing in liquid funds
5. Who should invest in liquid mutual funds?
6. Major advantages
7. How do liquid mutual funds work?
8. How to invest in liquid funds?

What is a liquid fund?

A liquid fund is a type of mutual fund that primarily invests in money market securities and debt instruments. These funds are designed to provide a level of income that is consistent with the objectives of relative stability of capital, maintaining relatively lower risk, and ensuring high liquidity.

A liquid mutual fund is able to achieve these objectives by focusing its investments on instruments with a maturity of up to 91 days only. Essentially, the assets within a liquid mutual fund portfolio are those that can be quickly converted to cash. They include treasury bills, commercial paper, and other short-term instrument.

Liquid funds can be a suitable choice for various investors, including individuals as well as corporates managing short-term cash flows. These funds are also suitable for those looking for alternatives to the traditional savings account, and those desiring short-term, low-risk investment options.

Additionally, liquid funds can serve as an avenue for building contingency or emergency funds. Investors who wish to keep their money in a relatively low-risk basket, until a suitable equity asset class opportunity arises, can also find liquid funds beneficial.

To summarise the liquid mutual funds meaning, they can serve as a suitable investment vehicle for investors prioritising relative stability, liquidity, and decent potential returns.

Read Also: Liquid funds vs fixed deposits

Step-by-step process to invest in liquid funds

Now that you have understood what is a liquid mutual fund, let’s learn how you can invest in it. Investing in liquid funds offers a straightforward way for investors to park their surplus funds while aiming for relatively stable returns. Here’s a step-by-step process to invest in liquid funds:

Identify a suitable platform: You can invest through distributors, or invest in liquid fund online platforms. Many Asset Management Companies (AMCs) provide a smooth, guided process for purchase through easy-to-use portals.

Register: Register on your chosen platform by providing your details. This would typically include PAN card, Aadhaar card for KYC verification, and bank details

Select the right fund: Explore the various liquid funds available, along with their respective returns and ratings, and choose one that aligns with your financial goals. There are various benefits of liquid funds and choosing a suitable scheme can help you inch closer to your financial goals.

Investment amount: Decide the amount you wish to invest. Liquid funds don't have a lock-in period, making it flexible for investors to redeem whenever they wish.

Purchase: Click on the 'invest' or 'buy' option to purchase the desired fund. Follow the prompts.

Start an SIP (optional): If you wish to invest regularly, set up a Systematic Investment Plan (SIP). It allows you to invest a fixed amount at regular intervals automatically.

Completion: Once the payment is processed, the units of the fund will be reflected in your account. You can track the performance of your investment in real time through the platform's dashboard.

Benefits of investing in liquid funds

• Relatively better return potential: When it comes to investment avenues, the major advantage of liquid mutual funds is that they tend to offer an enhanced investment experience compared to traditional product. Their structured investment approach often results in a relatively better return potential.
• Relative stability of investment: Liquid funds can offer a shield against market volatility by investing predominantly in highly rated money market and debt instruments with up to 91 days of residual maturities. This allows the principal to remain relatively stable, making the fund less susceptible to market fluctuations.
• Cash management flexibility: With features like the Insta-Redemption facility (up to Rs. 50,000), liquid funds provide the flexibility of immediate cash access. This is especially beneficial in case of emergencies or unplanned expenses. Moreover, with a T+1 settlement timeline, investors can redeem their units at any time, making cash planning more efficient.
• Versatility in investment: For those waiting for the right market conditions or opportunities in the equity asset class, a liquid fund can provide a shelter to park funds temporarily. It helps keeps the money relatively stable.
• Relatively low risk: Given that liquid funds primarily invest in highly rated instruments with short maturities, the associated risk is minimal. This makes them a preferable choice for conservative investors or those who prioritise relatively low volatility.

Factors to consider before investing in liquid funds

Before investing in liquid funds, it's crucial to consider various factors to ensure they align with your financial goals and risk tolerance. These funds offer a low-risk investment option, primarily in short-term debt instruments, making them suitable for investors looking to mitigate the impact on capital with modest returns while maintaining liquidity.

Liquidity: One of the main reasons for choosing a liquid fund investment is its high liquidity. However, always check the average maturity period and the assets where the fund has invested to gauge its liquidity.

Investment horizon: Liquid funds are better suited for short-term goals or when you have some surplus cash that you might need soon. Their maturity period does not exceed 91 days.

Returns: While liquid funds might offer a relatively better return potential than a savings account, the risk associated is higher. Review past performance, but remember, past returns do not guarantee future performance.

Exit load: Liquid funds come with an exit load, which is a fee charged if you withdraw your investment within a specified period. Always check for any such conditions.

Who should invest in liquid mutual funds?

Liquid mutual funds can be suitable for individuals and businesses with specific financial requirements. Here are some potential investors:

• Individuals with short-term surplus funds: Those with extra money they may need in a few weeks or months can consider liquid funds. This includes individuals waiting for an investment opportunity or those looking to park emergency funds.
• Individuals managing cash flow: Liquid funds can help maintain financial flexibility by providing relatively easy access to funds, making them beneficial for cash flow management.
• Investors seeking relatively lower volatility: Compared to equity or longer-duration debt funds, liquid funds tend to experience relatively lower fluctuations, making them suitable for those prioritizing principal preservation over potentially higher returns.
• Those exploring alternatives to savings accounts: While savings accounts provide liquidity, liquid funds may offer the potential for slightly higher returns, though they come with market-related risks.
• Investors looking for a temporary holding option: Those planning to invest in equity or longer term debt funds can use liquid funds to prevent their money from remaining idle while finalizing investment decisions.

Major advantages

Liquid mutual funds provide several potential benefits, mainly in terms of liquidity and relatively lower volatility. Here are some key advantages:

• High liquidity: A major advantage is the ease of redemption. Investors can usually withdraw their funds within one business day, making liquid funds suitable for short-term cash management.
• Relatively lower volatility: Compared to equity funds or longer-duration debt funds, liquid funds tend to have relatively lower fluctuations, which may appeal to investors prioritizing principal preservation.
• Flexible holding period: Investors can stay invested in a liquid fund for any duration they choose. This makes liquid funds a suitable choice for those looking to maintain a contingency reserve.
• No exit load: Most liquid funds do not impose an exit load, allowing investors to redeem their investments without additional costs.

How do liquid mutual funds work?

Liquid mutual funds function by investing in short-term debt and money market instruments. Here’s how they operate:

Investment in short-term instruments: These funds primarily invest in securities maturing within 91 days, such as: treasury bills (T-bills), commercial paper (CPs), certificates of deposit (CDs), and other short-term debt instruments.

Net asset value (NAV): The NAV reflects the per-unit market value of the fund’s assets after deducting liabilities. It fluctuates based on changes in the market value of the underlying securities.

Fund management: A professional fund manager oversees the portfolio, making investment decisions in line with market conditions and the fund’s objectives.

Redemption: Investors can redeem units at the prevailing NAV, with the redemption process typically being quick and efficient.

How to invest in liquid funds?

Investing in liquid mutual funds is a relatively simple process. Here are the common methods:

• Through mutual fund distributors: Investors can invest via registered mutual fund distributors or financial advisors who provide guidance and assist with the application process.
• Directly through asset management companies (AMCs): Many AMCs allow direct investments through their websites or mobile apps. This option can potentially help investors save on distributor commissions.
• Online platforms: Various online platforms and mobile apps facilitate mutual fund investments. These platforms provide an easy way to compare and invest in different liquid funds.

Steps involved

• KYC compliance: Ensure KYC requirements are met, as they are mandatory for all mutual fund investments.
• Choose an AMC or platform: Select a suitable AMC or online platform for investment.
• Select a liquid fund: Research and choose a liquid fund that aligns with financial objectives, considering factors such as the expense ratio and fund performance.
• Make the investment: Decide on the investment mode (lump sum or SIP) and proceed with the payment.

Conclusion

Liquid mutual funds can be a suitable option for investors looking for high liquidity and relatively lower volatility for short-term investments. They can offer the potential for slightly better returns than traditional savings accounts while allowing easy access to funds. However, unlike savings accounts, returns are not fixed or guaranteed and depend on market conditions. Investors should assess their financial objectives and risk tolerance before investing and stay informed about the latest tax regulations on debt funds.

FAQs:

How long should I stay invested in liquid mutual funds?

Liquid mutual funds can be suitable for parking of surplus cash, building an emergency reserve, saving for short-term goals etc. They provide relatively high liquidity, allowing quick access to your money. However, returns depend on market conditions. These funds however will not typically offer potential for inflation-beating returns in the long term.

Where do liquid mutual funds invest?

Liquid mutual funds primarily invest in short-term debt instruments such as treasury bills, commercial papers, and certificates of deposit, with maturities of up to 91 days. Their objective is to offer high liquidity and relatively stable returns that align with money market rates.

Who should invest in liquid funds?

Individuals or entities with surplus funds that they need to park for a short period can consider a liquid fund mutual fund. These may include those looking to park emergency funds, businesses managing temporary cash surpluses, or investors waiting to allocate funds elsewhere.

How much return can you expect from liquid funds?

Liquid fund returns are influenced by prevailing market conditions and interest rates. They have the potential to offer better returns than savings accounts, but returns are not guaranteed and can fluctuate.

Are liquid funds better than a bank's term deposit?

Liquid funds provide higher liquidity than term deposits, enabling quicker access to funds. While term deposits offer fixed returns, liquid fund returns may vary. The choice depends on individual priorities between liquidity or fixed returns.

Are liquid fund returns taxed?

Capital gains from liquid funds are taxed upon redemption. The gains are added to the investor’s taxable income and taxed as per their applicable slab rates.

What is liquid mutual fund?

Liquid mutual funds are short-term investments that typically have a maturity of up to 91 days or less. They are known for their high liquidity and can be a suitable option to park one’s money for a short duration. This is the liquid funds meaning.

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