Is it suitable to invest in liquid funds during a low interest rate scenario?

The impact of low interest rates has been felt by investors who predominantly invest in fixed-income investment instruments like fixed deposit (FD). Thus, it is important to look for alternatives. Mutual funds are known to offer relatively better return potential than traditional savings account with marginally higher risk as compared to savings account. In fact, certain schemes like liquid funds come at a relatively low risk and offer high liquidity that may be preferred by conservative Indian investors.
So, are liquid funds suitable to invest in the current financial landscape? Let’s find out.

• Table of contents:

1. What are liquid funds and how do they work?
2. Four important features of liquid funds
3. Investing in liquid funds in a low interest rate scenario
4. Impact of Low Interest Rates on Liquid Fund Returns
5. The Case for Investing in Liquid Funds During Low Interest Rates
6. Strategies for Optimizing Liquid Fund Investment in a Low Interest Rate Environment
7. Why you should invest in Bajaj Finserv Liquid Fund

What are liquid funds and how do they work?

Open-ended mutual funds that invest in short-term debt instruments with a residual maturity of up to 91 days are known as liquid funds. The fund manager invests in certificates of deposit (CD), commercial papers, treasury bills, government securities and bonds to get relatively stable returns on investment with minimum impact to the principal amount.
You can invest in liquid funds if:

• You are a conservative investor.
• You are new to mutual fund investments.
• You want to park surplus cash for relatively better return potential.
• You are looking for a short-term investment.
• You want an investment instrument that offers high liquidity.
• You want to build a contingency fund.
• You want to meet your short-term financial goals like funding a vacation, buying a home appliance, etc.

Four important features of liquid funds

Here are the features you should know before you invest in liquid funds:

Risk level: Because of the relatively lower risk level as compared to other debt mutual fund schemes, many Indian investors seek to invest in liquid funds. Liquid funds also tend to have a low interest rate risk, credit risk and inflation risk.

Liquidity: Since liquid funds are open-ended mutual funds, you can easily redeem them by placing a request. You can opt for insta redemption facility, wherein, you can redeem up to Rs. 50,000 or 90% of the invested amount, whichever is lesser instantly.

Return on investment: You can consider opting liquid funds instead of bank FDs and savings accounts. They offer better liquidity than FDs since you may have to pay a penalty on breaking an FD before maturity period. In contrast, liquid funds may not charge an exit load if the investments are held for more than 7 days. Also, liquid funds usually offer better return potential than those from your savings account. However, unlike savings accounts, the returns from liquid funds are not fixed and are subject to market risks.

Investment portfolio: Debt funds like liquid funds bring an element of relative stability to a dynamic portfolio. With a liquid fund, you get the added benefit of investing in government securities amongst other securities that otherwise have a high minimum investment requirement for retail investors.

Investing in liquid funds in a low interest rate scenario

Most equity funds come at a high risk with a better return potential. Thus, investors who prefer low-risk investment tend to favour debt funds. The interest rate risk associated with liquid funds is lower as compared to other types of mutual funds. You can consult your financial advisor to make sure that it is suitable for you to invest in liquid funds in the low interest rate scenario. While liquid funds offer predictable returns, they may not outpace inflation. For potentially higher returns, consider a disciplined investment approach through a mutual fund SIP . You can explore a SIP interest calculator to see how regular investments can grow your corpus over time.

Impact of low interest rates on liquid fund returns

Low interest rates can have a noticeable but limited effect on liquid fund returns. Here's how:

Reduced interest income: Liquid funds primarily invest in short-term debt instruments like treasury bills and commercial papers. In a low-interest rate environment, the income from these investments decreases, impacting returns.

Impact on bond prices: While less significant than with longer-term bonds, falling rates may cause slight price increases in short-term debt securities, offering a minor boost to returns.
Liquid funds are relatively less affected by interest rate changes due to their short-term nature, compared to longer-term debt funds. Although returns may be lower in low-rate environments, liquid funds can still outperform low-risk alternatives like savings accounts.

The case for investing in liquid funds during low interest rates

Despite the impact of low interest rates, liquid funds remain a strong choice for short-term financial goals and emergency funds due to their liquidity, low risk, and relatively reasonable returns compared to other low-risk options.

While low interest rates can reduce liquid fund returns, they still offer significant advantages:

Higher returns than savings accounts: Even in a low-interest rate environment, liquid funds tend to offer better returns than savings accounts, helping preserve purchasing power against inflation.

Liquidity: Liquid funds retain their liquidity, making them ideal for emergency funds, short-term goals, and temporarily parking surplus cash.

Low risk: By investing in short-term, high-quality debt instruments, liquid funds minimize the risk of capital loss, providing stability in uncertain times.

Strategies for optimizing liquid fund investment in a low interest rate environment

In a low-interest rate environment, you can enhance your returns from liquid fund investments with these strategies:

Focus on expense ratios: Choose liquid funds with lower expense ratios, as lower expenses positively impact net returns, particularly when interest rates are low.

Consider ultra-short-term debt funds: These funds invest in instruments with longer maturities, potentially offering higher returns but with increased interest rate risk.

Explore arbitrage funds: Arbitrage funds take advantage of price differences in the market, offering relatively better returns but with added risk compared to liquid funds.

Utilize tax-efficient strategies: Choose the growth option to defer tax payments, benefiting from lower long-term capital gains tax rates.

Why you should invest in Bajaj Finserv Liquid Fund

You can get a relatively better return potential by investing in Bajaj Finserv Liquid Fund than traditional banking products like savings accounts and FDs. However, the returns are subject to market risks. The scheme invests in debt and money market instruments with a maturity period of up to 91 days. It currently falls in the low-to-moderate risk category and offers high liquidity. The good part is that you can start your investment in Bajaj Finserv Liquid Fund with just Rs. 1,000.
In conclusion, liquid funds can be a suitable option in the low interest rate scenarios if investors align their investment with their short-term financial goals. The ‘low risk, high liquidity’ combination makes liquid funds a suitable investment avenue for all types of investors.

FAQs:

Are liquid funds a good choice during declining interest rates?

In falling interest rate scenario, the rates are declining because the fixed income as securities prices are rising. So, in a rallying market, one wants to ideally be invested in such opportunities where return potential can be maximised. For that reason, in the falling interest rates scenario, investment in long term securities tends to be more performance generating.

How do liquid funds perform when interest rates fall?

Since liquid funds have maturities of 91 days or less, they tend to be less affected by falling interest rates compared to longer-term fixed income investments. Their short-term nature and diverse portfolio help reduce the interest rate risk to marginal level. Since they offer relative stability and liquidity, potential returns might be lower during such periods. Prioritize your financial objectives before investing.

What factors to weigh before investing in liquid funds?

When considering liquid funds, assess your investment horizon, risk tolerance, and expected returns. Professional advices are vital for making informed decisions tailored to your financial situation.

Can I expect higher returns from liquid funds in a low-interest-rate environment?

In a low-interest-rate environment, liquid funds may not deliver significantly higher returns due to the short-term nature of their investments. While they offer relative stability and better returns than savings accounts or fixed deposits, their returns may still be subdued..

What are the risks of investing in liquid funds when interest rates are low?

In a low-interest-rate environment, investing in liquid funds can involve risks such as lower returns, inflation eroding purchasing power, and opportunity cost from missing higher-return investments. While credit risk is minimal, it cannot be entirely eliminated.

Should I consider other investment options instead of liquid funds in a low interest rate scenario?

In a low-interest-rate environment, alternatives to liquid funds worth considering include arbitrage funds, short-term debt funds, dynamic bond funds, gold ETFs, and equity-oriented mutual funds. Each offers varying degrees of return potential and risk, so assessing your risk tolerance, investment horizon, and diversification strategy is crucial before investing.

How can I optimize returns from liquid funds in a low interest rate scenario?

To optimize returns from liquid funds in a low-interest-rate environment, focus on minimizing costs by choosing funds with low expense ratios, prioritize high-quality debt instruments, and explore short-term debt funds for slightly higher yields. Regularly monitor and rebalance your portfolio, and consider alternative options like ultra-short-term bond funds.

Are liquid funds safer than traditional savings accounts during low interest rates?

In a low-interest-rate environment, liquid funds can provide higher potential returns and tax efficiency compared to traditional savings accounts. However, they carry slight market risk and may not be as immediately accessible as savings accounts. The choice depends on your individual risk tolerance, goals, and financial situation.

How long should I invest in liquid funds during low interest rates?

In a low-interest-rate environment, liquid funds are best suited for short-term parking of funds, typically with a 3-6 month investment horizon. They are ideal for funds set aside for upcoming expenses. For longer investment horizons, consider other options like short-term debt funds or equity-oriented mutual funds for higher returns.

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 an 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.