Liquid mutual funds are one of debt funds. It requires a clear understanding of your investment horizon since they are categorized based on duration. From overnight funds to long-duration funds of 7 years, debt funds have been classified into 16 different categories. This move by SEBI is to help investors find the right type of fund without being overwhelmed by the choices. Here, we are going to explore Liquid Mutual Funds and talk about everything that you need to know about them before investing.
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What is a Liquid Mutual Fund?
A Liquid Mutual Fund is a debt fund which invests in fixed-income instruments like commercial paper, government securities, treasury bills, etc. with a maturity of up to 91 days. The net asset value or NAV of a liquid fund is calculated for 365 days. Further, investors can get their withdrawals processed within 24 hours. These funds carry the lowest interest-rate risk in the debt funds category.
How do Liquid Mutual Funds work?
The core objective of a liquid fund is providing capital protection and liquidity to the investors. Therefore, the fund manager selects high-quality debt securities and invests according to the scheme’s mandate. Further, he ensures that the average maturity of the portfolio is not more than 91 days. Shorter maturity makes the fund less prone to change in interest rates. By matching the maturity of individual securities with the maturity of the portfolio, the fund manager tries to deliver better returns. Liquid funds are known to offer better returns than a regular savings account.
Should you invest in Liquid Mutual Funds?
If you have a good amount of cash which is not invested anywhere and are looking for a short-duration investment option with lower risks, then liquid funds are ideal for you. Your money can earn better returns than merely lying in a savings account along with the same liquidity. Many investors use liquid funds as a stepping stone to investing in equity funds. They start with investing in a liquid fund and then initiate a systematic transfer plan to an equity fund. This helps them invest in equity funds in a phased manner and benefit from Rupee Cost Averaging.
Factors to consider before investing in Liquid Mutual Funds in India
Here are some important aspects that you must consider before investing in liquid funds in India:
Since the underlying assets of a liquid fund have a maturity of up to 91 days, they do not experience a lot of volatility. Hence, the NAV of the fund remains almost steady. This makes liquid funds low-risk investments. However, it is important to note that if the credit rating of any underlying security drops, then the NAV can experience a drop too. Liquid funds are NOT risk-free.
A quick look at the performance of liquid funds will tell you that these funds offer around 7-9% returns on an average. Hence, they are better than the 4% returns earned on savings account deposits.
Like all other mutual fund schemes, liquid funds also charge an annual fee for offering fund management services. This is called expense ratio – a percentage of the total assets of the fund. Funds with a lower expense ratio are preferred by most debt investors as it helps in maximizing their gains. Further, most fund managers of liquid funds invest and hold the security until maturity. Therefore, the fund does not incur expenses due to excessive buying and selling of securities keeping the expense ratio low.
Liquid funds are used by many investors to create an emergency fund. They offer reasonable returns at lower risks and are as liquid as savings account deposits. These funds are designed for investors with a 3-month investment horizon. Hence, before investing in these funds, ensure that you create an investment plan accordingly.