A liquid fund is a type of mutual debt fund that invests primarily in money market securities for a day. These funds have high liquidity, as the name suggests, and the returns are less volatile as these funds invest in very short-term securities that are maturing in very short.
Therefore, these funds have higher returns than savings deposits. Furthermore, as these funds invest in fixed income securities with smaller tenures, they offer lower yields than other debt funds.
Liquid funds have better returns in situations of high inflation as the RBI generally keeps interest rates high and tightens liquidity to curb inflation. The best things are that there is no entry load and exit load on liquid funds.
Since investors invest in short-term liquid funds, short-term capital gains are taxed on these funds based on the tax rate of the relevant income tax bracket for investors, say one day for a few months. Interest earned on a savings account is, however, also taxable based on the applicable income tax slab.
Given the above advantages, the following are the advantages of liquid funds, as explained below.
The advantages of liquid funds are-
- Ideal product for cash management:
Liquid funds are suitable for short-term investment rather than investing in the savings account. These funds invest in securities with less than 30-day maturity. Such funds are not locked in time. They can also be invested for a day.
- Less risky
Since liquid funds invest in securities that mature in a month in the short term. Such funds are less volatile than other debt funds as the default risk interest rate is lower in the near term.
- High yield
Liquid funds have returns ranging from 7% to 8% over the long term (3 years to 5 years), which is higher than the interest rates of many banks on savings accounts.
- Easy to redeem
Cashing out liquid funds is quick. You can redeem money with one day’s notice to someone when you redeem your investment in liquid funds before 2 pm. You will get cash in your account by 10 am the next day. The significant advantage is that you can make partial withdrawals in debt funds, which is not possible in the case of bank FDs.
Many liquid funds have instant redemption facilities (such as ICICI liquid funds). That ensures that when collecting redemption orders online, you automatically collect money in your bank account. The market regulator SEBI (Securities and Exchange Board of India), however, immediately gave an exemption amount of Rs. 50,000 or 90% of the portfolio value, whichever is less.
- Returns may exceed than bank FD
Return on liquid funds can be more than just a fixed deposit. Liquid fund banks can offer better returns in periods of high-interest rates relative to FDs.
- High liquidity
Liquid funds provide unique liquidity to the investors as the money remains invested for such a short time. Only funds allow investors to withdraw their investment if needed. Your income from liquid funds will be credited to your account within 1-2 days of redemption.