Finding the right investment option can be a very interesting exercise. Almost like a quick little game of strategy. It works like this — you tell us what you want from your investments, and we’ll tell you what investment options can fit your needs. For instance, say you want to invest in a low risk investment vehicle that is also easy to liquidate. In that case, here’s an obvious choice — liquid debt funds.
Liquid debt funds are a type of mutual funds that invest in certain specific debt instruments. These debt instruments have a maturity period that goes up to 91 days. Here are some examples of debt securities that meet this criteria:
These mutual funds typically choose such short term securities that carry a high credit rating. This helps lower the credit risk by a large extent. Furthermore, these funds have a very short term investment horizon. And since the prices of short-term securities do not fluctuate as much as the prices of long-term bonds, you’ll find that the returns from liquid funds are also quite stable.
Now that you know the meaning of liquid debt mutual funds, you may want to know more about the many liquid mutual funds in India. More importantly, you’ll need to know what kind of returns they have offered, both recently and historically. So, here is a list of some of the top liquid debt funds in the Indian financial market.
Liquid debt funds are not for everybody. Like all investment options, they may be better suited for investors with certain specific goals and needs. So, here are some scenarios where liquid debt funds may be ideal for your investment portfolio.
Liquid funds invest in securities with a maturity period of 3 months. They are also safer in comparison with funds that are linked to the equity market. So, if you want to invest in a low risk investment option for a very short period, these debt funds make for a good choice.
Due to their short maturity period, liquid funds are ideal for short-term goals like saving up for a premium gadget, taking an international vacation, or buying jewellery in the near future.
You may be planning a family holiday or a big purchase in 3 months’ time, and you may have the funds ready. But parking the money in your savings account means you may accidentally spend it on something else.
Here’s where liquid funds can be useful, since you can temporarily park your money in these investment vehicles and keep the earmarked money safe till your goal is due.
Your liquid debt funds can also help you invest in equity funds systematically. If you want to start an SIP in equity funds, you can hold your capital in liquid debt funds, and systematically transfer the money into equity funds periodically.
This way, you get the benefit of systematic equity investments as well as rupee cost averaging, while simultaneously earning stable returns from your liquid debt funds.
An emergency fund needs to be easy to liquidate and less susceptible to risk. Liquid debt mutual funds tick both these boxes. They invest in debt instruments that carry little risk, and they are easy to sell off if you need to get your hands on some emergency cash.
So, if you are planning to build an emergency fund while still earning decent returns on the money you put in, a liquid debt fund is a good option to consider.
Before you invest in a liquid debt mutual fund, you need to consider or be aware of some important pointers -
The expense ratio in liquid funds is typically lower than other debt funds that have a longer investment horizon. This is because the fund manager need not buy and sell securities very frequently. They simply hold the instruments till maturity, since the period is very short, coming in at just 91 days. So, although liquid funds do charge a fee, they are very nominal and help make the returns more cost-effective.
Liquid debt mutual funds carry very low interest rate risk, because the interest rates in the economy do not change much over a 3-month period. As for credit risk, this can be reduced by choosing funds with high credit ratings. In terms of returns, they typically offer higher interest than your average savings bank account, but give you the same level of liquidity. So, by investing in liquid funds, you can earn higher returns without compromising on liquidity.
Since liquid debt mutual funds are essentially debt funds, they are taxed in the same manner as all other mutual funds that invest predominantly in the debt market. Short Term Capital Gains (STCG) — which pertain to holdings up to 36 months — are taxed as per your slab rate. And Long Term Capital Gains (LTCG) — which pertain to holdings over 36 months — are taxed at 20% with indexation benefits.
This should give you some comprehensive insights into liquid mutual funds in India. Remember that liquid funds, like all debt funds, may be low risk but are not entirely risk-free. But due to their short maturity period, they are typically not vulnerable to many price changes. You can minimise the risk further by choosing liquid funds with a higher credit rating.
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A liquid fund is a type of debt fund. Debt funds in general, invest predominantly in debt securities. Liquid funds, being debt funds, also have a debt-oriented portfolio. However, they specifically invest mainly in debt securities with a maturity period of 91 days at most.
So, as for which is better, that depends on your financial goals and needs. If you are looking for a safe investment avenue, debt funds broadly meet this criteria. But if you want safe investments that are also highly liquid, you could consider liquid debt funds.
Mutual fund schemes that invest in short-term government securities like treasury bills, Commercial Papers (CPs) and Certificates of Deposit. These securities have maturity periods up to 91 days, making the mutual fund scheme highly liquid.
Yes, since most liquid funds are generally open ended, you can liquidate your holdings at any time. This makes debt funds belonging to this category perfect for anyone who wants to have easy access to their investments without taking on too much investment risk.
The interest rate on liquid funds tends to vary from one year to the next as well as from one fund to another. This is because of the difference in the portfolio asset allocation between funds, and also because the repo rates and the coupon rates on the securities are subject to change. On average, however, liquid funds have given historical returns of 7% to 9%.
