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Why is liquid mutual funds a must have in your portfolio

October 20, 2017 by Anirudh Dar

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Most of us keep our surplus cash lying in our savings bank account for short term needs. Savings bank is safe and convenient; we can draw our money at any time through ATM or a bank branch. The more money we have in our savings bank account, the more comfortable many of us feel.

However the comfort comes at a cost, because money in savings bank account is virtually unproductive. People with busy careers do not have sufficient time to think about how to invest the surplus money in their savings bank account; consequently, large sums of money accumulate in savings bank account and remain idle (unproductive) before investors figure out a use for them.

Liquid funds are mutual fund schemes, which offer almost the same convenience which savings bank offers and at the same time puts your idle cash to much more productive use. Liquid funds are very popular among corporate investors for parking the company’s surplus cash which they may need at short notice for their regular working capital needs. As a result they are able to earn much higher returns on their short term funds which otherwise would simply lie idle in their current accounts. Retail investors can also get substantially higher returns on their surplus funds compared to savings bank interest.

What are liquid mutual funds?

Liquid funds are money market mutual funds and invest in instruments like treasury bills, certificate of deposits and commercial papers and term deposits. The objective of liquid funds is to provide the investors with an opportunity to earn returns, without compromising on the safety and liquidity of the investment. Typically liquid funds invest in money market securities that have a residual maturity of less than or equal to 91 days. Liquid funds have no exit load and therefore you can withdraw money either partially or fully at any point.

See the performance of top liquid funds on our research section

Characteristics of liquid funds

Liquid mutual funds offer a high degree of safety and liquidity. As discussed liquid funds invest in money market securities which invest within 3 months. Very short term securities are is not affected by interest rate changes (bond yields) unlike debt mutual funds which invest in bonds and debentures. Therefore it is very rare for liquid fund NAVs to fall in value; therefore, the risk of capital loss is minimal.

Why do not you read how to select various kinds of debt mutual fund

These funds, as the name suggests, are also highly liquid. Withdrawals from liquid funds are processed within 24 hours on business days. Some liquid fund schemes offer instant redemption (money gets credited to your bank account within minutes) for transactions made through the AMC website or mobile application. Further, there is no exit load for liquid funds and you can redeem your investment, partially or fully at any point of time, depending on your needs.

Liquid funds usually give much higher returns than savings bank. Top performing liquid funds are currently giving around 6% annual returns, whereas savings bank accounts usually pay 4% interest. Also unlike savings bank, no tax is deducted at source on liquid fund returns for resident Indian investors. Hence, liquid mutual funds can help investors make their idle money much more productive instead of keeping them in savings bank accounts.

Liquid funds are ideal for parking funds even for a period of few days, few weeks or few months. For investment periods of 6 to 12 months, however, ultra-short term debt funds, another type of money market mutual funds,are better investment choices because it can give higher yield than liquid funds. Liquid fund is the best investment choice for money that investors may need to use at a very short notice and not committed to longer term investments like fixed deposits, post office small savings schemes, bonds and stocks.

Liquid mutual funds can also be very useful for investment modes like Systematic Transfer Plans (STPs). STPs are used when investors have sufficient lump sum funds to invest, but they are not sure about the price point at which to make the investment and want to take advantage of “rupee cost averaging” in volatile markets. Investors can park their lump sum money in liquid funds and transfer through STP to equity funds of their choice. Investors would earn much higher returns than savings bank on their lump sum (diminishing albeit) investment in liquid mutual funds and at the same time, take advantage of “Rupee Cost Averaging”.

Conclusion

Retail participation in liquid mutual funds in India is still very low. Convenience of keeping money in savings bank account and lack of awareness about liquid mutual funds prevent retail investors from earning higher returns. Liquid funds are excellent investment options for investors who have money lying idle in their savings bank account. You should consult with upto know more about how liquid mutual funds are suitable for parking your surplus funds for a short term.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.