Best Liquid Mutual Funds

The individuals who can easily start investing in these funds are:

1. Investors who Want an Alternative to Bank Deposits: Liquid funds can come with a good return rate, often much higher than bank deposits, for a shorter period of time. Therefore, it can be a better alternative for investors who are looking forward to greater returns than a bank deposit with minimal risks.
2. Short-Term Investors: As previously mentioned, the underlying assets of a liquid mutual fund will expire within a period of 91 days. Hence, it makes a good investment choice for investors who want to stay only invested for a maximum of three months.

While searching for the best performing liquid funds, the factors to be considered before investing are:

1. Risk Factor: Liquid funds are one of the least risky funds in the mutual fund environment, therefore, we can say the NAV does not fluctuate too often. However, there are still the chances for sudden drops in the net asset value of the fund. It can happen because of an abrupt decline in the credit rating of the underlying funds and bonds. 
2. Expected Returns: Liquid funds come with a greater interest rate than a savings bank account. Though the returns from the fund are not guaranteed, historically, they have mostly given positive outcomes. 
3. Horizon of Investment: This investment is highly suitable for investors who are looking to invest for a short span, which does not range over a period of 91 days. 
4. Costs Associated: Just like all other mutual funds, liquid funds levy a fee to manage the investments, and it is known as the expense ratio. But, based on the low-holding period, the expense ratio of liquid funds needs to be comparatively low, a factor you will have to look into.
5. Financial Goals: If you would like to create an emergency fund, then liquid funds can prove to be essential. Since these funds do not have a lock-in period, they can help you pull out money easily and quickly.

Minimal risk: These are associated with lower risk compared to most other mutual funds. They provide stability across different interest rate cycles in the market by investing in high-quality securities with a maturity period of up to 91 days. 

Low cost: The best liquid mutual funds are low-cost options as fund managers do not manage the portfolio of these schemes as actively as other types of debt funds. Most liquid funds have an expense ratio below 1%. This allows the fund to maximise returns for investors. 

Fast redemption process: Fund houses process the redemption request of investors within one business day. Moreover, there are some AMCs that process redemption requests immediately. This is possible only because the underlying securities of these mutual fund schemes are highly liquid. 

Flexible holding period: Investors may remain invested in a fund for as long as they want. They can even withdraw their funds in case of any urgency; no exit load is charged seventh day onwards from the date of purchase. That’s why these funds are a suitable option for investors looking to maintain a contingency fund. 

Choice of investment mode: Individuals can invest in liquid funds in two ways – lump sum and systematic investment plan. By choosing the lumpsum route, investors can allocate the entire amount to a fund in one go. Conversely, a SIP allows one to invest in a scheme by depositing a fixed amount at regular intervals (monthly, quarterly, etc.).

While finding the top liquid funds for your investment, ensure to check these risks-

1. Inflation Risk: Liquid fund returns are usually lower than other riskier funds (such as stocks and bonds). As a result of that, there is a chance that the rate of return may not keep pace with the market's inflation. The inflation risk rises with the maturity period of the bond. As liquid funds invest in short-term investments, the risk of inflation is low. 
2. Interest Rate Risk: Interest rate risk is the chance of a change in a bond's price because of fluctuations in the prevailing interest rates. With high interest rates, the bond would decline and vice-versa. 
3. Credit Risk: Liquid funds are never insured. Irrespective of the fact of money market mutual funds investing in high-quality securities, risk is always inevitable. There is a guarantee that you will get the invested capital when you choose to redeem your liquid fund units. 

FAQs

Q1. What is meant by a liquid fund?

A liquid fund is a form of mutual fund that invests in securities with a residual maturity of up to a period of 91 days. Moreover, these funds do not have a lock-in period since the underlying assets are not for the long term. 

Q2. How long should a person invest in liquid funds?

Usually, individuals choose to invest in liquid funds for short tenure ranging from a day to 3 months.

Q3. Are liquid funds better than a bank's term deposit?

Liquid mutual funds do not come with assured returns, yet they tend to provide higher returns than a term deposit. But, volatility is an essential factor that investors must consider before investing. 

Q4. Are liquid funds risk-free?

No. Although these funds do not hold a high-risk value, they are still exposed to the market, and the returns would not be guaranteed. 

Q5. Are liquid fund returns taxed?

If an investor sells the liquid fund units held for less than a period of 3 years, it would be taxed under short-term capital gains tax. 

Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.