Liquid Fund- Definition and How does it work?

Introduction

Liquid Fund can be defined as the basket of debt class assets or mutual funds that invest in securities with a maturity period of 91 days. These can easily convert into cash in a shorter period. Liquid funds include cash, money market instruments, and marketable securities, inventory, mutual funds, ETFs, etc.

The Net Asset Value (NAV) of a liquid fund is calculated for 365 days and within 24 hours withdrawal can be made by the investor. Liquid funds are a suitable option for those individuals who have excess cash and think they might need it back in few days. Liquid funds are less volatile and less risky because of the short maturity period and their Net Asset value does not fluctuate much. Rather than investing the money in a savings bank account, investing it in a liquid fund is a far better option. Direct plans are more suitable for the retail investor as liquid funds have a lower expense ratio, which in turn helps them to fetch a higher return.

Features of Liquid Fund

Liquid funds are open-ended debt class assets, where the investment is done for a short period of time, with a maturity of up to 91 days. There are some features of liquid funds which made them unique and attract a lot of investors are:

• The rate of return in a liquid fund is higher than the interest in a saving account. The best liquid fund in 2019 offers a 7%-9% of interest rate, whereas saving account return is 4% only.
• The maturity period of the funds is 91 days (3 months).
• The withdrawal of liquid fund money can be made with 24 hours of applying.
• There is no lock-in period in liquid funds which made it highly liquid in nature.
• The annual fee range from 0.30% to 0.70%.
• The minimum amount invests in liquid funds may vary from one scheme to another scheme.
• There is a low-interest rate risk as compared to other debt instruments.
• There are several investment options under liquid funds. It includes monthly daily dividend plans, dividend plans, week;y dividend plans, and growth plans.

How does Liquid Fund Work?

The primary purpose of liquid funds is to provide a high degree of liquidity to the assets and the safety of the capital to the investors. To attain this goal, the fund manager invests in the high rate debt instrument that matures within 91 days.

The allocated investment is done as per the individuals’ portfolio objective. The portfolio manager will ensure that the maturity period of the investment is three months. This makes the investment more liquid, sensitive, and less vulnerable. Also, the net asset value is calculated for 365 days. The NAV of the liquid funds does not fluctuate much due to its maturity period, making it a low-risk instrument. The NAV application is hand over before 2 p.m. and withdrawal request money gets processed in the next 24 hours.

How to Invest in Liquid Fund?

An individual gets good liquidity and low-interest rate risk through liquid funds. It is considered one of the best investment options for a shorter period. liquid funds can be seen as a good alternative to fixed deposits. Mainly all the schemes offer a redemption process where funds are deposit back within 24 hours after the approval of the application.

By contacting a registered broker or through the official website of a fund house, individuals can easily engage their money in liquid funds. The only thing to communicate is the personal details along with the investment option.

Investors can choose from the number of different liquid funds according to their suitability and accessibility. There is no much difference between all the liquid fund schemes, from the performance point of view. The investor must compare the performance against the benchmark and of the peer group.

Should you invest in Liquid Fund?

If an individual has a good amount of cash and looking for a short-term investment with immediate liquidity but with lower risk can invest in the liquid funds. Although, at the same time, individuals’ money can get a better return than saving accounts with the same liquidity.

Some investors, use liquid funds as a first step towards equity investment. They start investing in liquid funds and then take the transfer plan to the equity fund.

Factors considered while investing in Liquid Fund

Before allocating the money in liquid funds, the investor must clarify how the liquid funds work. Here are some essential factors which are kept in the mind of investors while choosing any liquid funds.

#1 Risks

As the liquid fund has a mature within 91 days only, they are not highly volatile as compared to other funds. Also, the Net Asset Value (NAV) of liquid funds is calculated for 365 days through which it remains almost steady. Thus, this makes the liquid fund less risky to the individuals. But we can not say that liquid funds are risk-free because, if the credit rating of underlying security drops, then NAV will also drop down up to a certain extent.

#2 Average Returns

There is an average return available in liquid funds because it will mature in three months. But still, its return is higher as compared to a saving account with the same liquidity option. On average liquid funds generate 7% to 9% return which is higher than 4% in the saving account.

#3 Tax Payable

Investors do not pay any tax on the dividend income from the mutual fund. If they earn a capital gain, then their income is taxable. The tax rate is dependent upon the holding period. If the capital gain is earned within a period of 3 years, it is known as Short Term Capital Gain (STCG) in which individual tax slab is applicable according to the income group. Whereas, if the capital gain is earned for more than 3 years, know a Long Term Capital Gain (LTCG) in which 20% of the tax rate is applicable.

#4 Time

The maturity period of liquid funds is within 91 days, which is very less than any other form of investment. This factor made liquid funds less volatile with minimum risk.

#5 Expense Ratio

Liquid funds involve a minimum amount of expense for managing the money which is known as the expense ratio. This s a fee charged by the fund manager for the execution of the whole process. Till now, the Security & Exchange Board of India (SEBI) fixed the expense ratio to be 2.25%

Advantages of Liquid Fund

There are several advantages including in the liquid funds, which made it very popular than other debt assets as:

• Investors can get access to their money within 24 hours of applying.
• As the maturity period is 91 days, the net asset value of the liquid fund does not fluctuate much. So, it involves the least risk.
• There is no entry or exit load attached to the liquid funds like other funds.
• Only 2.25% of maximum expenses are involved in the liquid funds which are very lesser as compared to other debt instruments.

Disadvantages of Liquid Fund

There is a black side of liquid funds, as it is less volatile but still have some issues as:

• There is no tax benefit included in the liquid funds. The investor has to pay tax under two heads as STCG and LTCG based on the time period of the investment.
• Liquid funds are also linked to the market. Hence, they experienced fluctuation in Net Asset Value due to which there is no guarantee in the liquid funds.
• There is a management fee included in the liquid funds. Unlike, when you open a bank account there is no management fee because the bank only holds your money. Whereas, the fund manager manages your money due to which includes a 2.25% expense ratio which is set by the Security & Exchange Board of India (SEBI).

Liquid Funds provides an investor the opportunity of investing their capital for a very short period of time say 91 days with an attractive rate of return. An investor can protect his/her investment against volatility because net asset value does not fluctuate much.

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