Should you invest in Liquid Funds?

Liquid Funds are a popular investment option to park your surplus money for a brief period of time, at a rate of interest which is higher than what a bank generally offers. This is an open-ended debt scheme which invests in treasury bills, money market instruments, commercial paper and certificate of deposits for up to 91 days.

There are a number of factors which make Liquid Funds an attractive option.

Lower risks

To begin with, Liquid Funds are supposed to be least risky as they hold high quality papers. Among the different categories of debt funds, liquid funds have the shortest maturities. They earn returns from the accrual on the instruments and these funds do not involve trading.

Liquid Funds are often compared with Ultra short term funds. However, the two are different on many counts. Firstly, the maturity period for the Ultra short term fund is more than three months and often goes up to a year. Ultra short-term funds are a riskier preposition on the basis of the quality of papers they hold. Furthermore, Liquid Funds do not charge an exit load, whereas Ultra short-term funds put an exit load on the investor.

Better returns

In general, Liquid Funds give returns of over 6-8%. Compare this to the average 4% rate of interest offered by most banks for savings account. The better returns easily make it an obvious choice from an investor’s point of view.

Easy liquidity

There is no exit load charged on liquid funds. In fact, there are now provisions in some funds that allow an investor to redeem their funds within a few hours. Hence, the process that used to take a couple of days earlier is now complete within some hours. Overall, on the basis of the cut-off schedule for redemption, an investor receives money the next day.

Taxation

Liquid funds are taxed like any other debt fund. When profits are realized in less than three years, the same are taxed as per your tax rate, while the profits realized after three years are taxed at 20% with indexation. Investors who come in the 30% tax bracket can opt for a dividend payout if they require cash on a regular basis.

Conclusion

Liquid Funds give an investor the option of investing their capital for a very short duration of time at an attractive rate of interest. The option of redeeming the funds within a span of some hours makes the investment option a very lucrative one.

These funds are best suited as a contingency fund where you can set aside some amount of your investment by a creating a contingency fund.

This route also works well when an investor wants to invest lump sum money and then, in course of time, transfer it systematically it to equity funds. In general, it is not advisable to invest lump sum in equities market at a time when the markets are volatile or are richly valued. Liquid Funds can be a useful tool during such times as money can be parked here with an instruction for STP into an equity fund at regular intervals. By doing so, an investor can protect the investment against the volatility and, at the same time, the money is already invested in an option that gives better returns.