Liquid funds belong to the debt category of mutual funds. They invest in very short-term market instruments like treasury bills, government securities and call money. They are getting popular with retail investors as they offer much higher returns than a savings bank account and because you can cash out in a day
1. When should you invest in liquid funds?
Liquid funds are used by investors to park their money for short periods of time typically 1 day to 3 months. For example, if you are saving money for a vacation to be undertaken three months from now, you could park it in a liquid fund. Many equity investors also use liquid funds to stagger their investments into equity mutual funds using the systematic transfer plan (STP), as they believe this method could yield higher returns and help them beat volatility over a period of time.
2. How fast can such funds be redeemed? What return can an investor expect?
Once an investor gives the redemption request before the cut-off time on a business day, the money reaches their bank account the next working day. There is no entry or exit load by fund houses in liquid funds. As per data, the category of liquid funds has given a return of 6.84% over the past year. This is higher than the 3.5-6% offered by banks on their savings account.
3. What is the risk of investing in liquid funds?
Financial planners consider liquid funds to carry lowest risk as well as least volatility in the category of mutual funds. This is because they generally invest in instruments with high credit rating (P1+). The net asset value of these funds sees a change to the extent of interest income accrued, including on weekends.
4. How are liquid funds taxed?
Liquid funds held for more than three years are eligible for long-term capital gains tax with indexation. If you sell before three years, you have to pay tax as per your tax slab. If you opt for the dividend option, the fund will be subject to a dividend-distribution tax of 28.84%.