Liquid Funds - What are Liquid Funds? Risks & its Benefits

Liquid Mutual Funds are a dynamic investment option worth considering. Let us delve into Liquid Funds, understand what they are, how they work and whether they are the right investment choice for you.

What are Liquid Funds?

Liquid funds, often referred to as Liquid Mutual Funds are Debt Funds that primarily invest in short-term debt instruments with very short maturity periods, often less than 91 days. These instruments can include government securities, certificates of deposit, commercial paper and more. Investors can quickly and easily redeem their units in these funds, often within 24 hours.

Investors are attracted to Liquid Funds because of their safety and stability. While they may not offer high returns associated with riskier investments, they are ideal for those seeking to park their funds temporarily, whether it is the bonus from your salary, an emergency fund or money being kept aside for a short-term goal.

How do Liquid Mutual Funds Work?

Liquid Funds pool money from various investors to generate steady, short-term returns while maintaining high liquidity. Professional fund managers manage the funds and decide where to invest the pooled money. The portfolio consists of a diversified mix of short-term debt instruments. These instruments have a relatively lower interest rate risk due to their shorter maturity.

The primary objective of Liquid Funds is to preserve the capital while delivering a reasonable return. Fund managers constantly monitor the fund's portfolio and make investment decisions that align with this objective. The short maturity period of the underlying instruments ensures that investors can easily access their funds when needed.

Liquid Funds: 5 Advantages offered by liquid funds

Liquid funds provide you with several advantages, especially if you are an investor looking to strike a balance between liquidity, safety, and returns. Let’s discuss some of the major benefits offered by liquid funds:

1. Offers High Degree Liquidity

Liquid funds provide a high degree of liquidity to investors, allowing easy conversion of their investments into cash with no major losses. With no lock-in period, you can access your funds quickly, with redemption requests usually processed within 24 hours.

2. Reduced Risk for Short-term Investment

Investing in high-quality debt securities considering short maturity periods, mostly up to 91 days, liquid funds minimise exposure to interest rate fluctuations. This short-term nature of investments is suitable for conservative investors who need stability in their profile.

3. Potential for Higher Returns

During inflationary periods, liquid funds offer steady returns to investors, making them an attractive option with modest but reliable returns.

4. Low Exit Loads and Expense Ratio

Expense ratios and exit loads play a crucial role in determining the net returns of a Mutual Fund investment. The expense ratio implies the annual fee charged by the fund house to manage the fund, which also covers administrative and operational costs. Lower expense ratios mean more of your returns stay with you. Liquid funds have lower expense ratios (0.1% to 0.3%) compared to equity funds (1% to 2%) and other debt funds (0.5% to 1%). For example, if two liquid funds generate an annual return of 6%, but one has an expense ratio of 0.2% and another 0.5%, the first fund will yield a higher net return.

Exit loads are minimal or non-existent if redeemed after seven days, unlike other funds that may charge up to 1%. Choosing a fund with a lower expense ratio and no exit load ensures maximum returns for short-term investments.

5. Tax Benefits with Indexation

Liquid funds provide tax benefits to investors, with debt taxation applicable after a holding period of three years. Upon redemption, investors can enjoy indexation benefits, treating profits as long-term capital gains.

Who Should Invest in Liquid Funds?

Liquid funds are considered the best option for investors looking for stable investment options, with good returns. The following investors can consider investing in Liquid funds:

1. Short-Term Investors

Individuals or entities willing to make short-duration investments with lower risks may find liquid funds appealing. One of the major reasons is the modest and low-risk returns, mostly up in 91 days.

2. Cash Reserve Holders

Those holding surplus cash which they don’t require immediately can consider liquid funds. These funds provide an avenue for storing excess funds, offering slightly higher returns compared to the traditional way of investment.

3. Investors Transitioning to Equity Funds

Liquid funds can help those investors who look to transition from conservative to more growth-oriented investments, including equity funds. The liquidity and stability of liquid funds make it an attractive option for investors who want to move towards higher risk gradually.

4. Emergency Fund Builders

Many investors use liquid funds to have their emergency funds due to their low-risk nature, competitive returns, and high liquidity. These funds also offer quick access to funds when you have any unforeseen incident and need for money.

Ultimately, individuals, corporations, trusts, and institutions, looking for high liquidity, low-risk investment options with the potential for competitive returns can plan investment in liquid funds. However, investors should have detailed research and analysis which align well with their financial needs and circumstances.

Top Liquid Funds to invest in

There are many factors to consider when it comes to choosing the best liquid Mutual Funds. These factors include past performance, expense ratio, asset quality, and liquidity. Based on thorough research, we have listed the top funds you may consider.

1. ICICI Prudential Liquid Fund G

ICICI Pru Liquid Fund is one of the top-performing liquid funds, offering consistent returns with low volatility. It has a strong portfolio of high-credit-rated instruments, ensuring stability.

2. Bandhan Liquid Fund Reg G

Bandhan Liquid Fund is known for its efficient fund management and strong risk control. It invests in short-duration, high-quality securities, ensuring steady returns.

3. HDFC Liquid G

HDFC Liquid Fund is a well-established scheme known for its consistent track record. With a low expense ratio and a strong fund management team, this fund is a suitable choice for short-term financial goals.

4. Tata Liquid Reg G

Tata Liquid Fund has a well-diversified portfolio, focusing on high-quality money market instruments. It provides stable returns with minimal risk. The fund is designed for investors seeking quick access to their money while earning better returns.

5. SBI Liquid G

SBI Liquid Fund is one of the most trusted liquid funds, offering competitive returns with high liquidity. It has a strong risk management framework and has consistently delivered stable performance.

We have selected the above funds based on many factors like credit quality, risk-adjusted returns, and expense ratios. These invest in short-term funds and offer high liquidity, allowing easy redemption within 24 hours. 

How to start investing in Liquid Mutual Funds with ICICI Bank

If you are thinking of investing in Liquid Mutual Funds with ICICI Bank, here are the steps to invest online:

1. Using Internet Banking

• Log into Internet Banking

• Go to ‘Investments and Insurance’ and then click on ‘Buy Mutual Funds’

• Choose from the ‘Top Categories’ or look into other plans

• After deciding on a suitable Mutual Fund, enter the desired investment amount and complete the transaction.

2. Using the iMobile app

• Log into iMobile

• Go to the ‘Invest’ tab, tap on ‘Mutual Funds’ and choose a suitable Mutual Fund

• Enter the amount and start investing. 

Why to Consider Liquid Mutual Funds in Your Portfolio

Liquid Mutual Funds are an excellent choice for investors seeking a balance between stability, liquidity and reasonable returns. Here are some scenarios where you might consider investing in Liquid Funds:

1. Temporary Parking of Funds

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   Liquid Funds are ideal if you have a lump sum amount and are planning to wait, to invest it. It provides better returns compared to a regular Savings Account, while keeping your funds easily accessible.

2. Safety and Predictability

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   Liquid funds are suitable if you prefer safety and predictability in your investments. They carry lower risks compared to many other types of Mutual Funds.

3. Quick Access to Funds

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   Liquid funds provide high liquidity, meaning you can redeem your investment quickly, often within a day. It makes them a reliable choice for short-term financial needs.

4. Slightly Higher Returns:

   While Liquid Funds may not offer exceptionally high returns, they provide better returns compared to a traditional Savings Account, making them an attractive option for those seeking a balance between safety and returns.

Liquid Mutual Funds: Factors to consider before investing in India.

Before you decide to invest in Liquid Mutual Funds in India, several factors need to be taken into consideration, such as:

1. Investment Horizon :

   Liquid Funds are best suited for short-term financial goals or temporary parking funds. If you have a longer investment horizon, other types of Mutual Funds might be more suitable.

2. Risk Tolerance :

   While Liquid Funds are relatively low-risk, assessing your risk tolerance and ensuring that this investment aligns with your comfort level is essential.

3. Financial Goals :

   Clearly set your financial goals and assess whether Liquid Funds support these objectives. For long-term goals, other investment options may be more appropriate.

4. Liquidity Needs :

   Consider how quickly you need to access your funds. Liquid Funds offer high liquidity, but other factors, like processing time, can affect the speed at which you can access your money.

5. Safety of Investments :

   While Liquid Funds are considered safe, it is essential to understand the credit quality of the debt instruments in the fund's portfolio.

6. Potential Returns :

   While Liquid Funds aim to provide reasonable returns, these may be lower than the returns that Equity Funds offer. Make sure the potential returns align with your financial objectives.

Taxes on Liquid Funds

Taxes on liquid funds depend on how long you hold them. If you sell within 3 years, you'll face Short-term Capital Gains (STCG) taxed at your income tax slab rate. Hold for over 3 years, and you'll deal with Long-term Capital Gains (LTCG), taxed at a flat 20% rate, with indexation benefits.

A Liquid fund offers stability and adaptability, drawing in a diverse range of investors. They're low-risk and suitable for short-term goals or for diversifying a portfolio. Picking the right fund involves considering returns, expense ratios, fund size, and diversification. Moreover, understanding taxation is key to making informed investment decisions.

Thus, liquid funds have varying taxes based on how long you hold them: STCG within 3 years and LTCG after 3 years, with indexation benefits. 

FAQs 

What are the best Liquid Funds for short-term investments?

The best liquid funds are selected based on various factors like high liquidity, past performance, expense ratio, and higher returns in short-term investments. The list of best liquid funds includes ICICI Prudential Liquid Fund, SBI Liquid Fund and HDFC Liquid Fund.

How safe are Liquid Mutual Funds?

The liquid funds are safe because they invest in high-quality, short-term debt instruments. However, they are not completely risk-free, as interest rate fluctuations and credit risk may impact returns. Carefully consider all factors before choosing.

How do I choose the best Liquid Fund?

In order to choose the best liquid fund, take into account multiple factors such as past returns, expense ratio, credit quality, and fund size. Go for funds investing in AAA-rated securities and government instruments for safety. You can also compare fund performances across different market conditions.

Is a Liquid Fund better than FD?

They both serve different goals. Liquid funds offer higher post-tax returns than FDs and provide better liquidity. Unlike FDs, liquid funds have no lock-in period, allowing easy withdrawals. However, FD rates are fixed, while liquid fund returns vary based on market conditions, making them riskier.

What is the lock-in period for Liquid Funds?

Liquid Mutual Funds do not have a lock-in period, allowing investors to withdraw money anytime. However, some funds may charge an exit load if redeemed within seven days of investment. This makes liquid funds an excellent option for short-term and emergency savings.

How does SEBI regulate Liquid Funds?

SEBI regulates liquid funds by imposing guidelines on portfolio composition, liquidity requirements, and risk management. It mandates funds to invest in high-quality short-term instruments and limits exposure to risky assets. These regulations ensure investor protection and maintain fund stability.

Can I use Liquid Funds for emergency funds?

Yes, liquid funds are an excellent option for emergency funds due to their high liquidity and better returns than other savings options. They allow quick redemption, often within 24 hours, making them suitable for urgent financial needs while keeping the money invested efficiently.