What is Liquid Mutual Fund? A Complete Guide

Managing surplus funds efficiently can be a challenge, especially when you need both safety and quick access. This is where liquid mutual funds come in. Designed for temporary financial demands, they provide a consistent approach to save idle money and generate steady profits.

This article will explore what is meant by liquid mutual funds, their features, benefits, and the risks associated with them.

What is Liquid Mutual Fund?

Liquid mutual funds are a subset of debt mutual funds that invest in short-term market instruments in order to offer high liquidity and consistent returns. Mostly, these funds deploy their assets to securities with maximum 91-day maturities including commercial papers, certificates of deposit, and treasury bills.

Liquid mutual funds’ primary goal is to provide a quick access to the invested money while nevertheless providing a safe and effective place for investing extra money. They serve people and companies looking for low risk, swift investment options.

Key features of liquid mutual funds include:

• Short-Term Investments: These funds invest in premium instruments that mature in 91 days, thus ensuring less market volatility.
• Low Interest Rate Risk: Their brief lifetime reduces their sensitivity to changes in interest rates.
• Stable Returns: Though they are not guaranteed, the returns are usually constant and higher than the rates of savings accounts.
• Suitability: This strategy is suitable for those trying to maximise idle money for temporary needs like emergency finances or liquidity for future projects.

Those looking for a quick mix of safety, liquidity, and returns would prefer liquid mutual funds.

Benefits of Liquid Mutual Funds

Understanding what is liquid fund in mutual fund reveals its various benefits, making it an attractive choice for short-term financial needs.

1. Liquidity: Unmatched liquidity is one of the best features of liquid mutual funds. Many funds let investors redeem their money immediately; others offer T+1 or same-day settlement. This makes them perfect for situations needing rapid cash access or for emergencies.
2. Low Risk: The primary investments made by liquid funds are in superior short-term securities with a maximum maturity of 91 days. This lowers interest rate risks by guaranteeing stability and lessens susceptibility to market volatility.
3. Better Returns Than Savings Accounts: Although savings accounts have nominal interest rates, liquid funds usually give superior returns without sacrificing accessibility. This makes them a more innovative alternative for investing surplus funds.
4. Flexibility: A broad range of people and businesses are served by liquid funds. They are ideal for handling temporary financial demands such as debt pay-off, covering unanticipated costs, or simply cash flow optimisation.

Those trying to strike a mix of safety, accessibility, and returns may find great assistance from liquid mutual funds.

Risks Associated with Liquid Mutual Funds

Although liquid mutual funds are usually seen as low-risk investments, they are not totally free from challenges. Here are some key concerns to be aware of:

1. Credit Risk: Liquid funds made investments in short-term debt securities like commercial papers, certificates of deposit, and Treasury bills. The issuers of these securities, however, are in danger of failing to fulfil their obligations. Fund managers usually give high-quality instruments first priority; therefore, this risk cannot be totally minimised.
2. Interest Rate Risk: Liquid funds are exposed to some degree to interest rate changes even with short-term maturities. Though the effect is far less than that of longer-term debt funds, a sudden increase in interest rates could somewhat impair the returns of these products.
3. Reinvestment Risk: Liquid funds usually reinvest in fresh instruments since they run with short-term maturities. Should interest rates drop, the reinvested money could produce smaller returns, therefore lowering the total portfolio gains.
4. Not Completely Risk-Free: Liquid mutual funds are not totally free of risks even if they are stable and less volatile than equity funds. Market conditions and economic factors can still influence their performance.

Knowing these risks helps investors match liquid mutual funds to their risk tolerance and financial objectives, therefore guaranteeing reasonable expectations from their investments.

Why Should You Invest in Liquid Mutual Funds?

Investing extra money with liquid mutual funds allows one to put it in a flexible and safe account guaranteeing quick access to the money. This is one of the factors that makes them regarded as a wise investment decision:

• High Liquidity: Liquid funds are great for temporary financial needs since they can be taken out in 24 hours.
• Low Risk: Investments are made in premium, short-dated debt instruments that decrease exposure to interest rate and credit risks.
• No Entry or Exit Loads: Most liquid funds do not charge additional fees for investment or withdrawal.
• Better Returns Than Savings Accounts: While returns are not guaranteed, they often outperform regular savings accounts.
• Professional Management: Experts ensure optimal allocation while keeping risks minimal.

For individuals seeking stability, liquidity, and greater than bank returns, liquid mutual funds are an amazing choice.

How to Start Investing in Liquid Mutual Funds?

Liquid mutual funds are easy to invest in and open to both novice and experienced investors. Use these guidelines to initiate your path of investment:

Step 1: Choose the Right Fund: Start by looking at and choosing a dependable liquid mutual fund depending on its past performance, expense ratio, and fit for your goals and risk tolerance.

Step 2: Complete KYC Requirements: As the mutual fund investments demand, be sure you follow the Know Your Customer (KYC) procedure. You could visit a registered distributor or the fund house offline or upload your documents online.

Step 3: Select an Investment Platform: Invest directly via the Asset Management Company (AMC) website, mobile apps, or reliable outside third-party brokers or financial apps.

Step 4: Minimum Investment: Liquid funds are easily available to a broad spectrum of investors since their entry point is usually inexpensive and lets you start investing even with modest amounts.

Step 5: Monitor Performance: Track the fund’s performance after invested utilising tools offered by the AMC or outside platforms. Regularly monitoring helps ensure your investment aligns with your financial goals.

These straightforward procedures can let you effectively invest idle money with liquid mutual funds, thus guaranteeing both accessibility and the best returns.

Factors to Consider Before Investing in Liquid Mutual Funds

Before making investments in liquid mutual funds, you should consider a number of elements to be sure they fit your expectations and financial objectives. Consider the following:

1. Investment Period: Usually covering a few days to many months, liquid mutual funds are best suited for short-term financial demands. For an emergency reserve or putting extra money, they are ideal.
2. Fund Returns: Review the fund’s historical performance to assess its consistency in delivering returns. Check the expense ratio as well; reducing costs will eventually help to increase net gains.
3. Credit Quality of Assets: Make sure the fund acquires government-backed debt or AAA-rated instruments, among high-quality securities. This minimises credit risk and ensures stability.
4. Redemption Policy: Understand the fund’s redemption process. Most liquid funds allow instant or same-day withdrawals, but some may have restrictions or minimal exit loads for withdrawals within a short period.

Analysing these elements will help you decide with knowledge and maximise the advantages of liquid mutual funds.

Tax Treatment on Liquid Funds

Investors who want to assure compliance and maximise rewards must first understand the taxation policies for liquid mutual funds. Here’s a brief overview:

• Short-Term Capital Gains (STCG): Your gains are regarded as short-term if you redeem your liquid fund units within three years of investment. This means they are sought after and taxed at your applicable income tax slab rate.
• Long-Term Capital Gains (LTCG): Units kept for more than three years count as long-term. LTCG from liquid funds are taxed at 12.5% without indexation advantages per Union Budget 2024.

Understanding these tax guidelines helps investors to plan their liquid mutual fund investments more precisely and make wise judgements.

Conclusion

Liquid mutual funds can be considered for individuals and businesses looking to optimise surplus funds while maintaining safety and accessibility. By investing in short-term, high-quality securities, these funds provide a balance of stability, liquidity, and better returns compared to traditional savings accounts. Whether you’re building an emergency fund or investing idle cash for short-term goals, liquid funds offer flexibility and ease of access.

Before committing, though, you should evaluate elements including credit quality, expenditure ratios, and your investment horizon. Although their risks are minor, knowing the related ones and establishing reasonable expectations will enable you to make wise judgements.Take control of your financial future today by visiting PowerUp Money and downloading the financial planning app now!