When it comes to investing in mutual funds, liquid funds are a common preference, especially for investors who are looking at investing in stable instruments.
But what are liquid funds, and how do they get taxed?
This blog seeks to make it easy for investors to understand liquid mutual funds and where or how they can fit within your investment strategy.
The term liquid funds means debt funds which are invested in short-term instruments such as treasury bills, repos, CDs, CP and many more. The present regulation of SEBI permits liquid funds to invest only in money and debt instruments having a maturity of 91 days or less.
The liquid mutual fund's return is subject to the market price of securities in the fund contemplated. Though the returns on these liquid MFs are slightly lower than those of other debt funds, they are still useful for investments since the prices of short-term securities do not fluctuate as dramatically as long-term bonds.
Liquid mutual funds aggregate funds from different investors to earn consistent, short-term appreciation with no lock-in period.
The portfolio consists of various short-term debt securities, which helps reduce interest rate risk. These investments are less affected by interest rate changes compared to long-term debt securities or bonds due to their shorter maturities.
The main goal of liquid mutual funds is to protect investments from losses while aiming for steady returns. Fund managers carefully oversee the portfolio to align with this objective.
Below are the most important aspects of liquid mutual funds that you need to be aware of:
Liquid funds have a low to moderate risk in terms of investment. These funds are less sensitive to changing interest rates because they invest in instruments with quick maturity of no more than 91 days.
This is because the short duration is useful in managing risk arising from fluctuations in market interest rates, whereby the prices of bonds with long duration are most likely to be affected. Hence, liquid funds are less risky than other debt funds that invest in securities having longer maturity periods.
Liquid funds offer high liquidity, a significant advantage for investors needing quick access to cash. Usually, investors can redeem their money within 24 hours on working days, making it suitable for situations requiring immediate access to extra funds.
The ability to convert instantly makes liquid funds a preferred choice for storing emergency funds compared to keeping them in savings accounts. Another advantage of liquid mutual funds is the vast redemption facility, where one can redeem up to Rs 50,000 or 90% of the invested sum.
Liquid funds invest in low-risk and high-quality money market securities. These moves help in diversifying risk across various securities and hence work towards lowering the total risk of the fund.
Must Read: Liquid Mutual Funds Measuring the Metrics to Choose the Best Fund
Let’s discuss some of the benefits offered by liquid funds below:
People who are looking to invest money only for a short duration, a few weeks or months, can benefit from the high liquidity offered in these funds.
Corporations and institutions use liquid funds to manage surplus cash effectively. They ensure liquidity and earn better returns compared to traditional savings accounts.
Liquid funds are especially beneficial for those in need of urgent money for emergencies. These funds offer quick access to funds, ensuring you can meet unexpected financial needs without delay.
Most investors prefer their investments to be highly liquid and readily accessible. This is particularly important for retirees relying on their savings to meet living expenses.
While liquid funds offer low-risk investments, they are not completely risk-free. You may still have to navigate through the credit risks which can arise from defaults happening at the issuers’ end. Fluctuations in interest rates can further add to your risks, impacting the overall value of the securities at the end.
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