Sharekhan Blog

What are Liquid Funds?

  • Mar 4, 2024

Among many, liquid funds are more secure choices. So, let’s talk about liquid funds in detail.

Liquid Funds Meaning

Debt funds, known as liquid funds, make investments in short-term assets such as commercial paper, government securities, treasury bills, repos, and certificates of deposit. Liquid funds are only permitted to make investments in debt and varied money market instruments with maturities of up to 91 days under SEBI regulations.

Moreover, the market value of the securities owned by a liquid fund determines its return. Nonetheless, relative to other debt funds, the returns on liquid funds are comparatively more steady because the prices of short-term securities fluctuate less than those of long-term bonds.

What are the Benefits of Liquid Funds?

Here are the benefits of liquid funds: -

1.    High Level of Liquidity

With the high liquidity provided by liquid funds, you can quickly turn your investment into cash whenever you need it. In contrast to conventional investments such as bonds or fixed deposits, which could have lock-in periods, liquid funds let you withdraw your money early without facing penalties.

2.    Stability and Safety

High-rated corporate bonds, government securities, and treasury bills are examples of low-risk investments made by liquid funds. Liquid funds are a secure way to stash away extra money because this cautious investment strategy protects your wealth and gives your investment portfolio stability.

3.    The act of diversification

Your investing portfolio will benefit from diversification when you invest in liquid funds. Liquid funds mitigate the impact of a single default by spreading the risk across multiple issuers by investing in a basket of short-term securities issued by different firms.

4.    Tax Effectiveness

Investing in liquid funds can be tax-efficient, particularly for those in higher tax bands. The long-term capital gains tax on liquid funds, which is less than the tax rate on the interest income from fixed deposits for the majority of investors, is applied on gains from liquid funds held for more than three years.

How Do Liquid Funds Work?

The primary goal of liquid funds is to give investors a high level of capital safety and liquidity. The fund manager makes investments in high-rate debt securities with 91-day maturities because of this. The proportions allotted correspond to the investment goal of the fund. The portfolio's average maturity will be around three months, thanks to the fund manager's oversight. This lessens the vulnerability of liquid funds and lessens the susceptibility of fund returns to changes in interest rates.

There are not many swings in the fund's value. Furthermore, the portfolio's maturity and the underlying securities' maturity are matched. It contributes to greater returns. Investing in liquid funds is a great way to hide away extra cash. These are safer havens with better returns than standard savings accounts. The goal of liquid funds is to mimic the liquidity of a savings bank account. There is no lock-in period for these funds. Liquid funds are a normal savings account that you can use to achieve better returns.

Who Should Invest in Liquid Funds?

1.    Individual investors

Liquid funds are an investment choice for those with excess money who want to earn more than standard savings accounts but still have ready access to their money.

2.    Business Investing

Liquid funds are a common tool used by businesses and corporate treasuries to effectively manage their short-term cash reserves, striking a balance between safety, liquidity, and profits.

3.    Allocation of Emergency Funds

The high liquidity of liquid funds makes them a good choice for emergency fund development because they enable investors to immediately access their money in case of unforeseen needs or financial emergencies.

What are the Things to Consider Before Making Investment Funds?

  1. Expense Ratio: The fund's expense ratio should be carefully considered as it has a direct impact on your results. To optimize your investment results, select a fund with a lower expense ratio.
  2. Previous Performance: Even if previous performance does not predict future outcomes, it is nevertheless crucial to consider a fund's track record before making an investment. Seek for long-term results that are steady and predictable.
  3. Investment Horizon: As liquid funds are short-term investments, be sure to have a well-defined time horizon for your investments. Penalties and reduced returns may arise from withdrawing your investment before to the maturity period.
  4. Risk Profile: Liquid funds are regarded as low-risk investments, but they do entail some risk. Prior to investing, determine how much risk you can tolerate.

The Bottom Line

For investors seeking low-risk, short-term investments with the potential for larger returns than fixed deposits or typical savings accounts, liquid funds are a great choice. But before making an investment, it's critical to learn about and comprehend the fund's performance, fee ratio, and investment plan.

Team Sharekhan
by Team Sharekhan

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