What are Liquid Mutual Funds?
Investments in assets having residual maturity of up to 91 days are made by liquid mutual funds, also referred to as debt funds. Liquid funds invest in debt and money market products with a residual maturity of 91 days or less, such as Treasury Bills, Commercial Paper, and Certificates of Deposit. They strive to offer investors a high level of liquidity, and they are regarded as one of the safest mutual fund categories.
Why invest in Liquid Mutual Funds?
High liquidity with no lock-in period: liquid funds have a high level of liquidity and no lock-in period. Investors always have the option to redeem their money if they need to.
Low risk: Liquid funds have some of the lowest interest rate risks when compared to other debt funds. This is because the underlying securities are of a short-term nature.
Easy redemption: Highly liquid mutual funds can be quickly redeemed. Redemption requests are typically handled in a single working day. The majority of liquid funds also provide quick redemption access for withdrawals up to Rs. 50,000 per investor per day per program.
Potential for higher returns: Compared to savings accounts, liquid funds tend to offer higher returns.
How Do Liquid Mutual Funds Work?
As long as the funds are credited to the collection account of the asset management company (AMC) before 2:00 pm and the application reaches the AMC’s branch before the deadline, the amount invested in a liquid fund before 2:00 pm of a trading day is processed according to the previous day’s net asset value (NAV). So, the applicable NAV is that of the day prior if a purchase transaction in a liquid fund is submitted on day X.
When redemption occurs, the money is credited to the investor’s account the following working day. As an illustration, redemptions received before 3 p.m. on Friday will be processed on Sunday’s NAV, with the payout occurring on Monday.
A liquid fund’s primary source of income is the interest it receives on its debt investments. A very tiny portion of their income may come from capital gains. This implies that bond prices rise when interest rates decrease and fall when interest rates increase.
– A liquid fund’s market value does not vary as much when interest rates change because it invests mostly in short-term securities.
– This implies that substantial financial gains or losses may not occur for liquid funds.
– Liquid funds frequently outperform other debt funds in an environment of rising interest rates because, while their interest earnings increase (as shorter-term securities that are about to mature are replaced by longer-term securities that pay higher interest rates), their market values suffer relatively less than other debt funds due to their investments’ lower sensitivity to interest rate movements.
Risks do exist with liquid funds. For instance, liquid funds are vulnerable to interest rate risk because they primarily invest in debt assets. Therefore, any change in the current interest rates may result in an increase or decrease in the price of the debt instruments, which will have an effect on the fund’s returns, and alter daily. Credit risk is also included in debt instruments. However, by adopting a cautious investment strategy, such as purchasing AAA-rated assets and sovereign securities, credit risk can be significantly reduced.
The Taxation of Liquid Funds
Investments in liquid funds are taxed as income, just like other mutual fund schemes. The tax consequences depend on how long you maintain your investments in the fund and whether you have a growth or dividend investment plan. If a shareholder chooses to receive a dividend, taxation will depend on the current government policy regarding dividend taxation for that particular type of shareholder.
Liquid funds may be subject to both short-term capital gains tax and long-term capital gains tax in the case of a growth plan.
Short-Term Capital Gains:
You must pay short-term capital gains tax (STCG) at the income tax slab rates if you invest in a liquid fund’s growth plan and redeem your investment before three years (36 months). This indicates that the profits are included in your income and taxed at the applicable income tax rate for your tax bracket.
Long-Term Capital Gains:
After three years (36 months), if you redeem your liquid mutual funds investments in India, you will be liable to long-term capital gain tax (LTCG), which includes indexation benefits and is taxed at a rate of 20%. Before computing the capital gain, the indexation benefit uses the cost of inflation index (CII), which is published annually by the government, to adjust the profits for inflation. The tax incidence on your long-term capital gains is typically decreased as a result.
When compared to other fixed rate, fixed tenure debt-oriented investments, liquid funds are ideal for improved post-tax returns and a variable holding time.
Who is a mutual fund distributor?
A mutual fund distributor assists investors in India with the purchase and sale of mutual funds. By attracting investors to the mutual fund scheme, the distributors of mutual funds are compensated. Additionally, they offer investors advice regarding the various plans offered by various mutual fund houses.
How To Select A Liquid Fund?
You should look at the following, just like when choosing any other mutual fund:
– Check the track record of a liquid fund for consistently strong performance and high portfolio quality while reading the offer document.
– Make sure to check the expense ratio of these funds before investing, because a fund with a lower expense ratio is more likely to generate higher returns.
– It is important to verify the credit quality and liquidity of the fund’s investment portfolio for both the short- and long-term in order to ensure that the fund is stable. Always choose a fund with a proven track record and avoid any that have experienced credit events or other liquidity-related concerns in the past. The primary goal of investing in a liquid fund is not asset growth but rather effective short-term cash management.
– Keep in mind that investing in liquid funds has many benefits, one of which is the high level of intrinsic liquidity that they provide.