October 26, 2020

Detailed Information About Liquid Funds And Their Main Benefits

3 min read
Liquid Funds

Liquid Funds

A liquid fund is a mutual fund class that invests mainly in money market instruments such as a certificate of deposits, treasury bills, business papers and term deposits. The lower maturity of these underlying assets helps a fund manager meet shareholder redemption demand.

Liquid funds come with various schemes such as growth plans, daily dividend plans, weekly dividend plans and monthly dividend plans. Growth plans declare no dividends, and the fund’s appreciation is reflected in the higher unit value.

Investors should choose their plan according to their requirements for convenience and liquidity. Retail investors can also invest in the direct scheme as they have a lower cost ratio, which allows them to achieve higher returns. Liquid funds are one of the best short term investment strategies in a high inflation setting. The Reserve Bank generally maintains high-interest rates during high inflation cycles and tightens liquidity, giving best liquid funds good returns. Many liquid funds have offered higher returns than bank-fixed deposits compared to last year, which imposes penalties on premature withdrawals.

Resident individual investors do not pay tax on dividends received under liquid schemes, but fund houses pay dividend distribution tax @ 28.325 percent (including surcharge and cess).

Individual investors who book profits in liquid funds before one year are taxed at the same rate as their income slabs. Besides, interest received from savings accounts is taxed at the same price. 

Main benefits of liquid funds:

Higher returns- Your cash in a savings bank account earns 4 percent interest per year. Some banks offer a 6% interest rate, which is slightly higher. However, in the last 1-year cycle, the best liquid fund has returned, on average, about 7 percent. On returns alone, a liquid fund is more than a savings bank account. 

Ease of redemption- There is no lock-in time for these liquid mutual funds. Deposits are quickly processed and investors receive cash in their bank accounts within 1 to 2 business days. 

Tax-efficient- In this situation, long-term capital gains (over three years) are taxed at 20% after indexing, while short-term capital gains are added to your income and taxed at the standard rate that applies to you. 

No Loads- Most liquid funds have no entry or exit load. 

Low risk- Liquid funds have the lowest interest rate among debt funds, as they primarily invest in short-term fixed-income securities.

Despite the many benefits, individuals should explicitly choose liquid funds to pour their surplus cash to operate based on savings or current bank accounts.

Ultra short-term bond funds, which can invest in securities with slightly higher maturities, are another similar class of funds. As a result, they have the opportunity to earn slightly higher returns. The downside is that they also increase their risk profile because they are more susceptible to uncertainty than a liquid fund. Companies are making full use of both liquid and ultra short-term funds to park their surplus cash.

Note: Here, an investor has the option to park his fund for a few days or months and get returns according to market rates for the holding period.

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