One of the major advantages of investing in mutual funds is that you can choose from a wide variety of funds to invest in based on your risk appetite. Liquid funds offer high liquidity, moderate growth, and pose a low interest rate risk to the investor. Read on to learn more about liquid mutual fund investments – how they work, the benefits of investing in them, and points to consider before investing.
How do liquid funds work, and where do they invest?
Liquid mutual funds invest in instruments whose maturity period is at most 91 days. They generally invest in securities with short maturity periods such as treasury bills, commercial papers, and certificates of deposit. They are generally considered to be safe, and highly liquid investment options. The market value of these funds remains stable and is not significantly impacted by price fluctuations due to interest rate changes.
What are the advantages of investing in liquid mutual funds?
Here are the key advantages offered by liquid mutual funds to first-time and seasoned investors:
- They pose a very low risk to the investor: Liquid funds protect the principal amount and offer steady returns to the investor. Since they invest in short-term securities, they remain relatively stable even during volatile market conditions.
- Liquid funds are cost-effective: Mutual fund houses don’t actively manage a liquid mutual fund, unlike other mutual fund categories like equity funds. These funds generally have an expense ratio below 1%, which also makes them a more affordable mutual fund category.
- They offer high flexibility to the investor: Liquid funds might charge a minimal exit load if the investor decides to withdraw their funds in the first seven days. However, besides this, they have a very flexible holding period, allowing investors to enter and exit the fund with convenience.
- They offer high liquidity to the investor: Liquid funds offer high liquidity to customers, so much so that they are often seen as alternatives to savings accounts.
Points that you must consider before investing in liquid funds:
Here are some points that you must consider before investing in a liquid mutual fund:
- Conduct a risk assessment of your investment portfolio: If you already have multiple low-risk investments in your portfolio, you can consider investing in a moderate-to-high risk investment instead of a liquid fund.
- Check if your liquid fund aligns with your investment goals: The value of investment goals might change over time. You can consider increasing your liquid mutual fund SIP contributions to align with your investment goals.
- Analyse the taxation of your liquid fund: If you hold your liquid fund units for less than 3 years before selling them, the gains that you will incur will be considered as “short-term capital gains” (STCG). These STCG will be taxed according to your income tax slab rate. However, if you hold your liquid fund units for longer than 3 years, the gains are treated as “long-term capital gains” (LTCG). You will receive indexation benefits, and your LTCG will be taxed at a rate of 20%.
In conclusion, liquid mutual funds are low-risk, liquid schemes that invest in securities that have a maturity period of 91 days. You must use an online calculator to calculate your liquid fund returns before investing.