How can liquid funds help in building a passive income?

In today's world with rising costs, it is important for individuals to build additional streams of income beyond their regular salary or business earnings. Passive income is the income generated on a regular basis with little ongoing effort once the initial process is set up. Sources of passive income include dividends and interest income from investments. Additionally, liquid funds offer investors an opportunity to generate regular passive income with even modest investments. Read on to learn more about the role of liquid funds in passive income.

• Table of contents

1. Understanding passive income
2. Role of liquid funds in building passive income
3. Factors to consider when investing in liquid funds for passive income
4. Benefits of Liquid Funds for Passive Income
5. How to Use Liquid Funds for Passive Income
6. Comparison: Liquid Funds vs Other Income-Generating Investments

Understanding passive income

Passive income differs from active income in that the former does not require ongoing time and effort. Some common sources of passive income include rental income from investment properties, royalties from past work like books, recurring revenues from blogs or YouTube channels, dividends from stock investments and interest income from fixed deposits or debt funds.

While building truly passive income requires initial work, ongoing income is possible subsequently with minimal effort. For example, writing a book involves considerable upfront work but royalty payments keep coming in without further involvement. Similarly, rental properties require work to invest in a property and find tenants initially, but rental income is regularly generated thereafter.

Liquid funds fit well as a source of passive income because they can generate income or returns with modest investments and minimal ongoing effort from the investor. Let us explore how liquid funds help build regular passive income or returns streams.

Role of liquid funds in building passive income

Liquid funds or liquid mutual funds are open-ended debt funds that invest primarily in short term debt instruments like treasury bills, commercial papers, and certificates of deposit. They aim to provide high liquidity along with a reasonable return potential. Below is the importance of liquid funds in passive income.

• Periodic payouts: Liquid funds declare their net asset value (NAV) on a daily basis and offer Income distribution cum capital withdrawal (IDCW) option either monthly, quarterly or periodically depending on the chosen option. This regular cash flow helps generate income automatically. However, in this scenario, the investors must note that the NAV will fall to the extent of IDCW of statutory levy, if any.
• Low minimum investment: Liquid funds have a low minimum investment amount which makes them accessible for building a passive income portfolio even for small investors.
• High liquidity: Investments in liquid funds can be redeemed anytime subject to exit load. This provides flexibility to investors for their liquidity needs without compromising on returns.
• Relatively stable returns: As liquid funds invest in low-risk short term debt, their returns are relatively stable compared to equity funds. The returns may not be high in comparison, but they aim to provide a steady stream of returns.

Thus, by investing modest amounts regularly in liquid funds suited to the investor's risk profile and goals, individuals can develop a recurring stream of reasonable returns with little effort over time. These reasonable returns then act as a supplementary passive income source.

Factors to consider when investing in liquid funds for passive income

While liquid funds provide an avenue to generate regular passive income, investors need to choose funds carefully based on individual risk appetite and time horizon. Some important factors to evaluate include the below.

• Expense ratio: Fund houses charge recurring fees called expense ratio to cover operational costs.
• Option type: In Growth option, the IDCW is not paid out but retained in the Option for relatively higher payout or returns while redemption as compared with IDCW payout options.

Benefits of liquid funds for passive income

Liquid funds can offer several advantages for generating passive income:

Higher returns than savings accounts: Liquid funds generally provide better returns than traditional savings accounts, helping your money grow faster. However, returns with liquid funds are not guaranteed.

Liquidity: These funds offer high liquidity, meaning you can access your money whenever necessary, which is important for managing unexpected expenses or investment opportunities.

Low risk: Liquid funds primarily invest in short-term debt instruments with low credit risk, making them a safer option for passive income generation.

How to use liquid funds for passive income

Liquid funds can be an effective tool for generating passive income. Here's how to make the most of them:

Regular contributions: Investing consistently through systematic investment plans (SIPs) or lump sums can help build a substantial corpus over time, creating a reliable source of passive income.

Dividend reinvestment: Reinvesting dividends from liquid funds can compound your returns, increasing the overall investment and boosting passive income.

Systematic withdrawal plan (SWP): Setting up an SWP allows for regular withdrawals, providing a steady income stream for your expenses or financial goals.

Comparison: Liquid funds vs other income-generating investments

Liquid funds are a popular income-generating option but are not the only one. Here's a comparison with other common investment types:

1. Fixed deposits (FDs)

Returns: Generally provide slightly higher fixed returns than liquid funds.

Liquidity: Less liquid, with penalties for early withdrawals.

Risk: Safer than liquid funds due to fixed returns but subject to inflation risk.

Taxation: Interest income is taxed based on your income tax slab.

2. Savings accounts

Returns: Offer the lowest returns compared to other options.

Liquidity: Highly liquid, with easy access to funds.

Risk: Virtually risk-free, but returns often do not outpace inflation.

Taxation: Interest income is generally tax-free up to a specified limit.

3. Debt mutual funds

Returns: Potentially higher returns than liquid funds and FDs, but with slightly higher risk.

Liquidity: Generally liquid, but redemption may take a few days.

Risk: Subject to interest rate and credit risk.

Taxation: Taxed according to short-term or long-term capital gains rules, depending on holding period.

4. Equity mutual funds

Returns: Offer potential for higher returns than other options but come with higher risk.

Liquidity: Generally liquid, but redemptions may take a few business days.

Risk: Subject to market fluctuations and volatility.

Taxation: Long-term capital gains are taxed at a concessional rate, while short-term gains are taxed as per your income tax slab.

Conclusion

Investors can build a substantial pool of liquid assets delivering passive income over the long term with limited involvement. Liquid funds, therefore, represent a practical instrument in one's financial toolkit to develop supplementary earning streams in a low-effort manner. For example, the Bajaj Finserv Liquid Fund is one such option worth considering for building a passive returns or income portfolio. Investors can explore starting an SIP in the Bajaj Finserv Liquid Fund to take advantage of its investment approach and earn potentially reasonable returns through a disciplined investment plan.

FAQs

How can liquid funds contribute to passive income generation?

Liquid funds can contribute to passive income generation through interest earnings. They provide regular payouts through IDCW announced on a periodic basis without requiring the withdrawal of the original capital invested. However, this will be applicable only to investors who opted for IDCW and after payout the NAV of IDCW will fall to the extent of payout and statutory levy.

What are the main advantages of liquid funds compared to other investment options?

Liquid funds offer high liquidity as investors can withdraw their money instantly in most cases, compared to other investments with lock-ins. They also provide a relatively better return potential than traditional savings accounts while maintaining lower risks than equity investing.

Can liquid funds provide a relatively stable passive income stream?

Liquid funds can potentially provide a consistent passive income stream as they aim to deliver steady returns through interest earned on debt investments. However, the interest rates and income may fluctuate with market conditions. Also, there is no assurance of returns or interest income from the liquid fund.

How do liquid funds generate passive income?

Liquid funds generate passive income through interest earnings from short-term debt instruments like treasury bills, commercial paper, and certificates of deposit. The income is distributed to investors as periodic dividends or through increased NAV. These funds offer high liquidity, low risk, and regular passive income opportunities.

Are liquid funds safe for passive income?

Liquid funds are considered relatively stable for passive income due to low credit and interest rate risk, as well as high liquidity. However, they offer no guaranteed returns, may not outpace inflation, and are subject to tax implications. Consider your risk tolerance and goals before investing.

Can I use liquid funds to build long-term passive income?

Yes, you can build a substantial pool of liquid assets delivering passive income over the long term with limited involvement. Liquid funds offer lower risk and liquidity.

How do I choose liquid fund for passive income?

When selecting a liquid fund for passive income, consider the credit quality, expense ratio, past performance, fund manager expertise, and fund size. Ensure the investment objective aligns with your goals and monitor performance regularly.

What is the best asset for passive income?

The best asset for passive income depends on your risk tolerance, investment goals, and time horizon. Other popular options include rental properties, REITs, dividend stocks, and peer-to-peer lending. Consider risk, investment horizon, and liquidity before making decisions. Always consult a financial advisor for personalized advice.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.