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What are liquid funds? What are the benefits of investing in liquid funds?

We often possess surplus funds that we want to invest for a short period. Investing in fixed deposits may not be ideal, given its lock-in period that could restrict you from accessing funds when the need arises. In such a scenario, liquid funds can become a beneficial investment avenue.

Among the many types of mutual funds, liquid funds are a type of debt funds that invest in debt and money-market instruments such as the certificate of deposits, government securities, commercial papers, treasury bills, term deposits, etc. They allow you to park your savings for a short period. Besides, you can withdraw the money any time without paying extra charges.

Who can invest in liquid funds?

Liquid funds can be ideal for investors looking to invest for a short duration and at the same time, bear the least amount of risk. Liquid funds are known to provide higher returns in comparison to a savings account. Just like you invest in mutual funds online, you can also invest in liquid funds.

Now let us understand the benefits of mutual funds.

Why invest in liquid funds?

  • High liquidity with no lock-in period

As the name suggests, liquid funds are highly liquid. They do not have a lock-in period. These funds allow investors to quickly redeem their mutual fund investment as and when they need funds.

  • Quick withdrawals

You can withdraw liquid funds in a short span of time and get the funds in your bank account within 24 hours. In fact, few liquid funds offer the facility of instant redemption. However, in case of instant redemption, you can only redeem Rs.50,000 or 90% of portfolio value, whichever is lower.

  • Minimum risk

Liquid funds primarily invest in fixed income securities such as government securities that have a high credit rating. Moreover, since liquid funds offer high liquidity owing to a brief maturity period, they are considered more stable than other debt funds. These funds also carry minimal interest-rate risk.

  • Comparatively high returns

Liquid funds can offer returns ranging between 7 to 8 per cent per annum for long-term investment (i.e. 3 to 5 years). Moreover, during inflation, the RBI maintains a high-interest rate on liquid funds and tightens the liquidity making them a lucrative investment option.

  • Tax benefits

Liquid funds provide valuable tax benefits. Although capital gains from liquid funds are subject to taxation, you get the benefit of indexation with 20 per cent tax on long-term capital gains.

On the other hand, short-term capital gains are taxed at the income tax slab rate based on your income.

  • No entry and exit load

A vital benefit of investing in liquid funds is the absence of a penalty when redeeming them before the maturity period.

Conclusion 

Liquid mutual funds offer high liquidity and low-interest rate risk, which makes them an ideal investment option for individuals as well as corporates. However, when you decide to invest in mutual funds, you need to analyse the fund holistically; keep in mind your financial goals, risk appetite and investment horizon.

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