What are Liquid Funds?

What are Liquid Funds
August 05, 2022

What are Liquid Funds?

Liquid funds

Liquid funds are a type of debt mutual funds that invest in securities with maturity of up to 91 days. The main purpose of liquid funds is to provide liquidity and capital protection for the investors. These funds invest in fixed income instruments like commercial papers, treasury bills, government securities etc. As per the fund’s investment objective, the allocation proportion is decided.

Who should invest in liquid funds and how do they work?

If you are looking for short-term investment options for idle cash you have, liquid fund is a good option to consider. The fund manager will ensure that the average maturity of the portfolio is 91 days. A shorter duration reduces the sensitivity of fund returns to interest rate movements. Furthermore, the maturity of the underlying securities is matched with the maturity of the portfolio which leads to better returns.  Liquid funds also do not have a lock-in period.  Liquid funds can give better returns than savings accounts and that too with the same liquidity. Liquid funds are considered as a first step towards investing and then gradually making a systematic transfer to equity funds.

Key things to consider before making investments in liquid funds:

1. Risk

As underlying instruments in liquid fund, have a maturity of 91 days, which is a short period of time, they do not experience a lot of volatility. This prevents the NAV of the fund from being significantly impacted by price fluctuations in the underlying asset price. However, if the credit rating of an underlying security drops, it is important to note that the NAV can also drop.

2. Returns

Liquid funds are a choice for many companies to park their surplus capital. Many firms leave capital idle in current accounts. Liquid funds, when compared to the current account in terms of returns, give around 5-6% returns. While the current account gives 0%. In both cases, liquidity is the same.

Also, for individuals keeping money in a savings account, generate 2.5% to 3% in the current scenario. Parking money in liquid funds can help them generate 5-6% returns in the current scenario.

3. Investment horizon

Liquid funds can be considered when the investor is looking for short-term investing options say up to three months.

4. Expense ratio

Liquid funds charge a small fee to manage your investment. It is called the expense ratio. As the fund manager holds the underlying securities until maturity, liquid funds offer a low expense ratio.

5. Financial goals

Liquid funds are extremely useful in the case of building an emergency fund. Liquid funds not only generate higher returns but also allow you to take out your money quickly in case of emergencies.

Don’t forget to check: Advantages and Disadvantages of Mutual Funds