What are Liquid Mutual Funds

Liquid funds are low risk mutual funds which are suitable for parking funds for very short durations ranging from a few days to a few months. We usually park funds, which may be required to be drawn at very short notice from our savings bank accounts. But the interest rates paid by savings bank accounts are very low and therefore, our funds are almost unproductive when they are lying in our savings bank account.

Normally, we do not look for returns when we keep money in savings bank account because liquidity is the most important consideration for us in such situations. However, by investing in liquid funds, not only you get almost as much liquidity as in your savings bank account, you can also get good returns on your investment in liquid funds. Even a relatively small percentage difference in returns (interest) between liquid funds returns and savings bank interest can have a substantial impact in rupee terms.

For example, if you have a Rs 50 lakhs lying in your savings bank account paying you 4% interest per annum for two months, you could have earned almost Rs 17,000 more in two months by parking the money in liquid funds, assuming liquid fund returns at 6% per annum. Sometimes the difference between the liquid fund returns and savings bank interest can be as high as 400 basis points or even more; the financial impact in such situations is much more.

Why is liquid mutual funds a must have in your portfolio

Liquid fund invest primarily in money market instruments like treasury bills, certificate of deposits, commercial papers, treasury bills etc,that have a residual maturity of less than or equal to 91 days, with the objective of providing investors an opportunity to earn more returns on very short term deposits (compared to savings bank or current bank accounts), without compromising on the liquidity of the investment. Liquid funds offer a high degree of safety; it is very rare for liquid fund NAVs to fall in value and the risk of capital loss in liquid funds is minimal.

Did you know what is NAV of Mutual Fund

Liquid mutual funds also offer high liquidity. Withdrawals from liquid funds are processed within 24 hours on business days. Some liquid fund schemes offer instant redemption, for transactions made through the AMC website or mobile application and the redemption amount gets credited to your bank account within a few minutes of the online or mobile transaction. There is no exit load for liquid; this means that, you can redeem your investment, partially or fully at any point of time, depending on your needs without any penalty unlike fixed deposits. Further, unlike savings bank or fixed deposit interest, no tax is deducted at source on liquid fund returns for resident Indian investors.

Liquid mutual fund returns are taxed as non-equity funds. Profits from liquid funds held for a period of less than 3 years are as taxed as per the income tax slab of the investor. Profits from liquid funds held for a period of more than 3 years are taxed at 20% after allowing for indexation benefits. Investors can also opt for dividends (daily, monthly etc.) in liquid funds. Dividends paid by liquid mutual funds are tax free in the hands of the investors, but the fund house has to pay dividend distribution tax (DDT) at the rate of 28.84% which is deducted from the dividend paid out to the investors.

Read the tax benefit of mutual funds versus other investment options

Liquid mutual funds can help investors make their idle money work instead of keeping them in savings bank accounts. Liquid funds are ideal for parking funds for a period of few days, few weeks or few months. Liquid mutual fund is the best investment choice for money that investors may need to use at a very short notice and not commit to longer term investments like fixed deposits, post office small savings schemes, bonds and stocks.

Visit our mutual fund research section to see which are the top liquid mutual funds