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What are liquid funds?
Liquid Funds invest in debt securities with very short maturities of up to 91 days (like lending to banks, short term govt. bonds and very short-term corporate paper). They provide full flexibility of anytime liquidity and earn returns in the form of interest for the holding period. They are highly secure due to kind of entities (Govt., Banks, Top Corporates (Small amount)). A number of corporates use liquid funds for their treasury management.
If held for less than 3 years, capital gains would be added to investor’s income and taxed at his marginal rate of tax but compared to FD which is taxed annually these funds are taxed on exit.
There are many Liquid Funds available in India that one can invest in but their performance is very similar. The most important feature we need to focus on while evaluating liquid funds is the lowest risk possible.
In terms of returns, they provide very similar returns as FD and you can withdraw anytime without any penalty.
Parameters used for the best liquid funds
- Size of fund: 5k Cr+
- Low Risk based on standard deviation of quarterly returns <0.2
- Average returns: annual, quarterly (annualized) to be 8%+ net of expense ratio
- Duration of portfolio to be < 1year
- Excluded Institutional Plans
- Exit load: Nil
- Credit quality to be AA or plus
Top Liquid Funds in India
- Kotak Floater Short Term Regular Plan
- Axis Liquid Fund
- Birla Sun Life Cash Plus
- ICICI Prudential Money Market Fund
Why opt for liquid funds?
Your hard earned money that lies in a savings bank account fetches you 4% interest per annum. However, the best liquid funds have returned as high as 8-9% on an average in the past 1-year period, daily, on an annualized basis. On returns alone, liquid funds score over a savings bank account. If you have a raise or a bonus coming your way, invest in liquid funds and party later. Even as compared to FD, the returns are higher in liquid funds. Look at the graph below for understanding how much the difference is costing you.
Liquid funds are invested in government bonds and high credited companies. The risks are the lowest with you can get when you’re investing in the market. They are the least risky and least volatile among mutual funds Liquid funds are like parking lots, you park your money while you are out doing something important, and when you come back to it, it appears to be washed and waxed. Whenever you want, you get your money back, and the profits are striking.
Easier tax implications
Your bank interest gets taxed at income tax rates (30.9% for the highest tax bracket; including surcharge). You need to collect TDS certificates, re-calculate taxes and submit it while filing returns. With Liquid funds, the interest income falls in Capital Gain income. In case it’s earned in less than 3 years, you need to pay tax, just like income. In case it’s after 3 years, i.e. its long term capital gain, the tax would be on interest earned after indexation. The overall tax rates come down to 8-9% instead of ~30% in case of FD for long term capital gain. So, you can constantly increase your money without getting as much tax cuts as in a fixed deposit.
No lock-in period
There is no lock-in period when you invest in liquid funds. You can withdraw at any time without getting charged a penny. All you have to do is notify for the request. The withdrawals from these funds are processed within 24 hours (business days). The cut-off time for the withdrawals is set at 2 pm which basically means if a request is made within 2 pm on a business day then the funds will get credited to your bank account within the next business day by 10 am. The fixed deposits on another hand, charge you if you withdraw before the maturity.
No entry and exit loads
There are certain funds that can be purchased without the sales charge and be withdrawn with no charges, cutting at your profits. Entry load is charged at the time an investor purchases the units of a scheme. Exit load is charged at the time of redeeming (or transferring an investment between schemes). Liquid funds are free from both.
Why are Liquid Funds better than FDs?
- Offer superior liquidity compared to bank FDs. Bank FDs would penalize you for pre-mature withdrawal.
- Returns are generally better than FD returns with slightly higher risk profile.