One safe place to put money for the short term, say a few weeks or months, is in a liquid fund. There is no assurance that you will not lose money or that you will get back what you put into the mutual fund. Even for very short-term investments, the structure of these funds makes them preferable to an interest-bearing fixed-term financial instrument. Let us look into what are liquid funds with examples in this topic.
Withdrawing your money from the fund is permissible at any moment, even the following business day. Because of this, investors can earn interest on their investments daily. The redemption of liquid assets is not subject to tax deducted at source (TDS). Some other instruments are not like this in this regard. Any exit load, or penalty for withdrawing from a mutual fund before the specified time period, is often waived for investments held for seven days or more. This reduces the expenses typically associated with investing in a mutual fund. Consider reading what are large-cap funds for more informative purpose on related topics.
What are Liquid Funds?
Treasury bills, commercial paper, government securities, and certificates of deposit are all examples of short-term market products that liquid funds invest in. Short-term investors can put their money into these investments, which have a maturity of up to 91 days, for periods of time as short as one to three months.
If an investor needs access to their money within a matter of days, weeks, or months, they can put their money in liquid funds. Liquid funds are the safest and most stable option for investing in debt. This is because they have mostly put their money into high-rated instruments.
Mutual funds can be categorize as “liquid” if they invest exclusively in debt and money market securities with maturities of fewer than 91 days. Funds that invest in short-term debt securities. Such as Treasury bills, Commercial Paper, Certificates of Deposit, and Bank Term Deposits, often have a maturity of 91 days or less.
Most of a liquid fund’s revenue comes from the interest it collects on whatever debt it may own. Even if it does make some money, it can be a tiny amount from capital gains. This indicates that a rise in interest rates is bad for bond prices and a fall in rates is good for bond prices.
Examples of Liquid Funds
Examples of liquid funds are SBI Liquid Fund, HDFC Liquid Fund, HSBC Cash Fund, Tata Liquid Fund and many more.
Because it invests mostly in short-term securities, the market value of a liquid fund is less sensitive to changes in interest rates. Therefore, it’s possible that liquid funds won’t gain or lose much from their investments. For the most part, liquid funds outperform other types of debt funds when interest rates are rising.
Capital losses are less sensitive to interest rate changes, so even while their interest revenues rise (as shorter-term securities mature and are parked in new ones with higher interest rates). Their market prices only fall by a moderate amount (because their investments have shorter maturities).
Even cash on hand can carry some risk. Liquid funds, which invest primarily in debt securities, are susceptible to interest rate risk. Fund returns fluctuate daily because of how interest rate fluctuations affect the value of the debt instruments held by the fund. Debt instruments are not risk-free either. However, sticking to a conservative investment plan and purchasing AAA-rated securities and other high-quality credit instruments can significantly lower credit risk.
Types of Liquid Funds
Understand how liquid funds function before committing capital. Due to their unique investment strategy, liquid funds are not suitable for all investors. Here are some things to consider before putting money into a liquid fund. As a buyer or seller in the money market, you need be familiar with the following instruments:
Certificate of Deposit (CD)
CDs, or certificates of deposit, are a type of term deposit that is analogous to a fixed deposit. Commercial banks included on the list provide these. You can access your funds at any time during an FD, but you can’t do that with a CD.
Treasury Bills (T-bills)
T-bills, or Treasury Bills, are short-term debt issue by the Indian government with a maturity of one year or less. Because the government guarantees them, these instruments are consider to be quite secure. Compared to other instruments, T-bills have a low return rate, often known as the risk-free rate.
Commercial Paper (CP)
CP (Commercial paper) is issue by financially stable businesses and organizations. Commercial papers, often known as promissory notes, are discount unsecured securities that must be repaid at par. That disproportion is the rate of return enjoyed by the investment.
How are Tax Calculated on Liquid Funds?
Similar to other types of mutual funds, investments in liquid funds are taxable as income. Your fund investments may be subject to taxation based on their age, whether you selected a growth or dividend plan, and the type of distributions you received. The dividend tax rate and policy of the investor’s home country will determine how much of each dividend the investor will owe in taxes.
When compared to traditional fixed-rate, fixed-term debt-based investments. Liquid funds can provide superior after-tax returns and greater holding period flexibility due to the way taxes are calculated. Your liquid assets may be subject to both short-term and long-term capital gains taxes if you have a growth strategy.
Long-Term Capital Gains
Investments held for more than three years (36 months) in a liquid fund are subject to long-term capital gain tax (LTCG). All indexation benefits are subject to this 20% tax. Gains are adjustable for inflation using the government-issued cost of inflation index (CII) before being utilize to calculate capital gain. In most cases, this reduces the tax burden associated with long-term capital gains.
Short-Term Capital Gains
Depending on your income tax bracket, you may owe short-term capital gains (STCG) tax if you invest in a growth plan of a liquid fund and withdraw the money within the first three years (36 months). This implies the gains are include in your taxable income and taxable according to your marginal tax rate.
Is it a Good Idea to Invest in Liquid Funds?
The same strategy can be use to make the most of a windfall if and when it occurs. This could be the result of losing a bank deposit, receiving a large annual bonus, or selling an item whose optimal use requires some serious consideration. Due to their nature, liquid funds are excellent short-term investments while you figure out your long-term strategy.
Long-term investors who have a large sum of money and want to invest it in a different asset class. Such as equities, on a regular basis through a systematic transfer plan, should consider liquid mutual funds (STP).
A similar method would be to invest a large sum of money into a liquid fund and then use the fund’s systematic withdrawal (SWP) option to create a monthly pension. It would start a steady flow of money coming in. All of a person’s monetary concerns can be easily met with the help of these resources.
Conclusion
To invest in a liquid fund is to invest in one of the mutual fund categories with the lowest risk. Institutional and retail investors alike are flocking to liquid funds for a variety of reasons. Investing in short-term debt instruments protects these funds from the effects of fluctuating interest rates. There are a variety of investing options available to you, including growth, dividend, and dividend reinvestment. Because of this, liquid funds are a good option for many different kinds of short-term investments.
