Liquid Funds

 

WHAT ARE LIQUID FUNDS?

LIQUID FUNDS are open-ended debt mutual funds that invest all its assets in short-term money market instruments with maturity in the range of 7 days to 90 days only.

The objective of LIQUID FUNDS is to offer its investors, means to park funds for a short period, help them earn better post-tax returns than what they get in their regular savings bank account and withdraw it as and when needed without any hassle or penalty.

These are the best debt instruments that individuals can use to replace their low yield savings bank account. The liquidity that these funds offer is so high that one can deposit their contingency funds into it including their monthly salary as most funds if parked for more than 7 days do not have any exit load.

LIQUID FUNDS carry minimum risk of default and interest rate fluctuations as they primarily invest in government securities, money market instruments such as Certificate of Deposits (CDs), Commercial Papers, Term Deposits, Call Money, Treasury Bills and so on.

The following are important details about LIQUID FUNDS that you are required to know before and after investing in this avenue.

 

 

IMPORTANT POINTS TO NOTE ABOUT LIQUID FUNDS

The following are some of the important features of the LIQUID FUNDS that every investor must know.

1. Investor’s profile – LIQUID FUNDS are most commonly used as a substitute for a savings account. It is best suited to investors who maintain a high balance in their savings account or do rolling of funds quite frequently. It invests all its assets in ultra short term money markets having maturity in 7 to 30 days.

 

2. Risk – LIQUID FUNDS carry minimum risk among all the debt products. It invests all its assets in short term money market instruments as its objective is to provide liquidity to its investors and not wealth creation.

 

3. Liquidity – LIQUID FUNDS is highly liquid and can be easily liquidated at any point in time. However, investors should check if the exit load is applicable before doing so. Generally, investments beyond 7 days do not have any exit load.

 

4. Taxation – Income from LIQUID FUNDS falls under debt taxation and hence considered as “Income from capital gains” and qualifies for indexation benefits if held for more than 36 months. However, it does not provide tax benefits.

 

5. Volatility – Volatility of LIQUID FUNDS is negligible since it is an open-ended scheme and does not invest in risky instruments. Also, the returns it offers are pre-determined and indicative.

 

6. Time horizon – LIQUID FUNDS are suitable for investors having a time horizon of not more than 30 days.

 

7. Regular Income – LIQUID FUNDS primarily invest all its assets in top-rated debt securities to provide instant liquidity to its investors hence they do not generate any income for its investors.

 

8. Returns – Since it is a market-linked product, its returns are not fixed. However, one can expect the average returns in the range of 5% to 9% depending on the quality of bonds where the investment is made and the duration of the investment. It should be noted that returns from LIQUID FUNDS are not guaranteed.

 

9. Asset class – LIQUID FUNDS are considered as debt instruments.

 

10. Cost – Fund houses charge expense ratio to facilitate mutual fund investments.

 

11. Loan facility – In case of emergencies, investors can pledge their mutual funds units as collateral to avail loan facility.

 

 

WHO CAN INVEST IN LIQUID FUNDS?

Any Indian resident, NRI, HUF or an institutional investor can invest in this scheme.

 

 

MINIMUM AND MAXIMUM INVESTMENT ALLOWED IN LIQUID FUNDS

One can start investing in debt funds with as low as 500/-. There is no maximum ceiling.

 

 

WHERE DO LIQUID FUNDS INVEST YOUR MONEY?

The funds accumulated in LIQUID FUNDS are invested in highly rated debt instruments like government securities, corporate bonds and deposits of various tenure issued by companies.

 

 

WHAT KIND OF RETURNS CAN LIQUID FUNDS GENERATE?

Returns generated by some of the liquid funds

 

 

FUND ACCESSIBILITY AND LOCK-IN APPLICABLE FOR LIQUID FUNDS

LIQUID FUNDS do not have lock-in and are available in various tenure from ultra-short term to short term. Investors with high liquidity needs having an investment horizon of not more than 7 days to 90 days can invest in LIQUID FUNDS.

 The ultra short term funds or LIQUID FUNDS are for those investors who wish to park their funds safely for a few days or want to have an option as a substitute for their regular savings account.

 

 

WHAT ARE THE BENEFITS OF INVESTING IN LIQUID FUNDS?

LIQUID FUNDS offers the following benefits to its investors.

1. Predictable Returns – Since LIQUID FUNDS invest all its assets in the money market and short term instruments, its returns are somewhat indicative and predetermined.

 

2. High liquidity and better substitute to savings account – Ultra short term debt funds or LIQUID FUNDS offer indexation benefit if held for more than 36 months. Also, the returns it generates are in the range of 5% - 7% depending on the holding period and market rates. This makes them a better alternative to most savings account deposits.

 

3. No TDS – Debt funds do not attract TDS which marginally increases their earnings. The tax is deducted only on returns it earns at the time of redemption.

 

4. SIP – Systematic investment plan is available in mutual fund investment which is one of the best ways of investing to take benefit of rupee cost averaging.

 

5. SEBI Regulated – Mutual funds in India are regulated by SEBI, who is their governing body. They restrict fund houses with their strict rules and regulations to keep their code of conduct and ethics in place and often protect investor's interests.

 

6. Low cost – Cost of investment in LIQUID FUNDS are comparatively low due to the low expense ratio.

 

7. Tax-efficient – If compared with other fixed return instruments like fixed deposits and bank savings account, it is more tax-efficient if held for more than 36 months as the returns it generates will be taxed at 20% with indexation benefit.

 

8. Expert Advice – One of the major benefits of investing in mutual funds is that you need not worry about choosing high-quality stocks and bonds to invest in. Successful investing requires a lot of research and knowledge. You need to dig deep into the financials of a company before you invest in it. Here, the fund manager does the job for you who is well qualified, understands the market dynamics and has competency in taking strategic investment decisions.

 

 

WHAT ARE THE LIMITATIONS OF INVESTING IN LIQUID FUNDS?

LIQUID FUNDS has the following limitations.

1. Moderate or Low returns – Since LIQUID FUNDS invest all its assets in short term money market instruments and other low yielding and safe assets, the returns they generate is comparatively low as compared to any equity mutual funds.

 

2. Opportunity Loss – Since LIQUID FUNDS do not take any exposure to equity, it loses out on every opportunity to earn more when the market is flourishing.

 

3. No guaranteed returns – Though it claims to give superior returns as compared to bank saving account, they are not guaranteed.

 

4. Difficulty in selecting the best fund – With the number of fund houses and options of funds that exist in the current scenario, investors are left confused with where to invest and how to choose the best fund and sometimes end up picking up the fund with very poor growth prospects. Hence, one should always take advice and use the knowledge of financial advisors.

 

 

WHO SHOULD CONSIDER INVESTING IN LIQUID FUNDS?

LIQUID FUNDS is most suited to the following investors:

1. Investors who want to invest for a very short period – Any investor who wants to park funds temporarily to meet their short term financial needs.

 

2. Low-risk-takers – It is best suited to individuals having surplus funds, who want to park it somewhere where they can earn predictable returns with the least impact of market fluctuations and wants to earn more than what they get in the savings account.

 

3. Senior Citizens – Individuals above 60 years of age who do not have an appetite to invest in risky instruments and wish to earn better post-tax returns than fixed deposits can diversify their investment and invest in LIQUID FUNDS.

 

4. Investors nearing retirement – Due to its low-risk profile, investors nearing retirement can start transferring their equity investments to this category as it provides higher stability. Post-retirement, investors may need funds anytime soon and any market correction or fall can put their retirement planning at risk.

 

5. Investors with high liquidity requirement – LIQUID FUNDS and ultra short term funds can generate much better post-tax returns as compared to regular savings bank account. Hence, those keeping high balance in their savings bank account can park funds here.

 

 

WHO SHOULD AVOID INVESTING IN LIQUID FUNDS?

LIQUID FUNDS may not be the best investment for the following investors:

1. High-risk-takers – Young investors especially below 35 years of age, who have age by their side and can take higher risk to earn much better returns in equity mutual funds or direct equities.

 

2. Investors with a long time horizon – Individuals having an investment horizon of 1 year or more can invest in balanced funds or other medium-term debt mutual funds.

 

 

A PIECE OF ADVICE

THINGS YOU SHOULD DO WHILE INVESTING IN LIQUID FUNDS

LIQUID FUNDS investors must follow the below suggestions while investing to maximize the value of their investment.

1. Perform due diligence – Never invest in mutual funds before verifying the credentials of the company and checking their credit rating. Though it is for the short term, sometimes funds take exposure to companies with low ratings to try to lure investors with attractive rates. But don’t fall in the trap as they are very risky. One should thoroughly study the risks involved in such instruments.

Also, investors should be aware that though LIQUID FUNDS in a way are considered as s, they do not guarantee returns. Thus, the returns they generate completely depend on the performance of the institution they have lent money to and various macroeconomic factors.

 

2. Compare expense ratios – “Expense Ratio” refers to the charges involved in investing in mutual funds. It also has a bearing on the overall returns the fund generates. Hence, always compare the expense ratio while investing, especially among the funds which are identical in all aspects and index funds. Hence, lower the expense ratio, higher the returns.

 

3. Know your investment goal – Mutual fund offers a variety of debt funds with different maturity and risk profile. Hence, one should bear in mind all pros and cons of investing in a particular fund.

The objective of LIQUID FUNDS is to help its investors park their money for a short period, earn better post-tax returns than what savings bank account offers and withdraw it as and when needed without any hassle or penalty.

Hence, investors looking for long term wealth creation should refrain from investing in LIQUID FUNDS.

                                                     

4. Analyze returns – Investors be aware that though LIQUID FUNDS in a way offer predictable returns, they are not guaranteed. Thus, returns it generates completely depends on the performance of the entity they have lent money to, as the company performance is subject to various macroeconomic factors.

 

5. Track your investments annually – It is very important to revisit your investment portfolio once every 6 months or at least once a year to review its performance. Its performance should be in line with its benchmark and other funds of similar nature. In case of any deviation, a decision needs to be taken after thorough analysis, whether to stay invested or to exit and look for a better performing fund.

 

6. Check exit load – It is important to study every aspect of the fund while investing in mutual funds. An exit load is a fee you pay for exiting from the scheme before one year. Hence, if you anticipate any possibility of liquidating your investment before the period as specified by the scheme information document, invest in a scheme without the exit load.

 

7. Gain Clarity – Scheme details and claim on returns should be verified with scheme information document at the time of investing. Investors sometimes get deceived by false claims from the agents and due to a lack of knowledge.

 

8. Update nomination details – Updating nominee details with the respective fund house is very important. In case of an investor’s death, the family members should not end up running from pillar to post when they need that money the most to claim your investment proceeds.

 

 

THINGS YOU SHOULD AVOID DOING WHILE INVESTING IN LIQUID FUNDS

LIQUID FUNDS investors must avoid indulging in following practices while investing to protect their investment from losing its value.

1. Investing in direct plans – Though investing in a direct scheme is cost-effective due to lower expense ratio, it loses the edge in the form of expert advice and services of your financial planner. Their attention and expertise in the subject can help you achieve much better returns which may surpass the saving you would have had by investing in direct schemes. As it is rightly said, sometimes, saving pennies can cost you fortune. Hence, choose a regular plan provided your portfolio is being managed by a competent financial advisor.

Some broking houses also provide a user-friendly and robust online interface to help you keep track of your investments and manage them effectively. It not only gives you a single-screen view of all your investments across different fund houses but also lets you carry out transactions at your ease. The only downside of having a middleman or a broker is higher expense by a very small margin to accommodate their commission payout but that is small enough to make a significant difference to your investment kitty.

 

2. Selecting a fund only based on past returns – Though past performance is one of the most important determinants of fund’s credibility, it should not be the only deciding factor while picking up the investment. The glorious performance in the past can be a result of various factors that may or may not exist in the future. Hence, one should make a note of sectors the fund is exposed to, the track record of the fund manager, etc while making a decision.

 

3. Do not get influenced by anyone but financial experts – A confused investor always has a tendency of reaching out to their friends and relatives for suggestions while making critical investment decisions. That happens irrespective of the knowledge and the level of understanding the friend has about the domain. It is as good as asking a truck driver, how to fly an airplane. Such advices in most cases are based on their individual experiences and hardly on calculations or facts and figures. Hence, instead of blindly following the financial advice of a random friend, investors must act wisely and take assistance of a well qualified financial planner who has sound knowledge about the domain.

 

 

HOW TO SELECT THE BEST LIQUID FUNDS?

LIQUID FUNDS investors must follow the below instructions before signing up for the product to ensure the safety and growth of their investment.

1. Get to the roots of the fund history – Before investing, find out as much information possible about the track record and stability of the fund. One should religiously study the portfolio composition of the fund. Then study the financial statements like Profit and Loss statement, cash flow statement and balance sheet along with the credit rating of the company they are investing in. The company which is low on debt and high on operating income is usually found to be more stable and involves a lower risk of default.

 

2. Know about the fund manager of that particular scheme – Fund manager is the key decision-maker of any scheme and they are the ones who run the show. It is very important to learn about their background like their qualifications, past performance, work experience, expertise in their line of business, a character like whether they have indulged in any unethical activity or do they have any criminal charges against them, etc. Also, their financial health and investment intelligence should not be ignored.

 

3. Select technologically sound broker – If you are investing through independent brokers then make sure they are well equipped with modern technology and systems. This will not only help you keep track of your investments online but also help you in making investments and redemptions yourself without depending on anyone.

 

4. Analyze performance – Where does the scheme stand against its competitors in terms of AUM size, market share, performance, etc. If the scheme has been in business for a while and still fails to build sizeable AUM or generate minimum returns against its benchmark and fellow competitors in similar schemes, then the reason for underperformance should not be ignored.

 

5. Always prefer funds with a good track record – A track record of the fund is important not just from a returns point of view but also from its strong corporate governance and ethics. If the fund is found deviating from its investment goal on a few instances or has displayed poor performance consistently should be avoided.

 

 

TAXATION RULES FOR LIQUID FUNDS

Income earned from LIQUID FUNDS are termed as “Income from Capital gains. However, the amount of tax applicable will be determined by the period of holding.

 If the investment in debt fund is held for less than 36 months then it will be termed as short term capital gains and anything beyond 36 months will be termed as long term capital gains.

Earnings in case of short term capital gains will be added to your total taxable income and will be taxed as per applicable slab. And in case of long term capital gains, the tax applicable will be 20% with indexation benefit.

 

 

HOW TO INVEST AND DOCUMENTS NEEDED?

1. Update KYC – The first and the most important requirement is updating KYC details with the registrar. This can be done by submitting the KYC form with your PAN card and address proof to CAMS office or your investment advisor or AMC.

 

2. Create a profile with a broker or a fund house – Then the profile needs to be created by updating your details with the registered broker or a fund house to open your account.

 

3. Register Online – Once the account is opened, one needs to set up a user ID and password to register online or on mobile application and then start making transactions.

 

4. Offline Mode – One time transactions can also be executed offline by filling a form of the particular AMC and issuing a cheque. To start SIP, the investor needs to sign the SIP mandate which specifies the amount and period of investment to set up auto-debit on the account.