Understanding Liquid Funds

Liquid funds are debt mutual funds with the objective to provide liquidity to the investors. So that investor can get his money anytime without looking at the market volatility. These funds are for the investors who are least bothered about the market movements and still want to park their money somewhere 'safe'. If you are looking to park your extra surplus for a very short period of time then these funds are for you.

Liquid funds invest in securities with a residual maturity of not more than 91 days. These funds are very good substitute for savings bank account if you plan to park your surplus amount. They invest in highly liquid money market instruments like treasury bills, certificate of deposits, commercial papers and term deposits.

Why Invest in Liquid Funds ?

• These funds provide good liquidity, low interest rate risk and the prevailing yield in the market. Liquid funds have the restriction that they can only have 10 per cent or less mark-to-market component, indicating a lower interest rate risk.
        
• If you have surplus in your savings account than you can park that extra money in liquid funds for extra benefit. Savings account will give you 4% return while liquid funds can give you around 7% return. This way you can get higher returns for the same amount. This doesn't mean you should park all your money in liquid funds. You should always keep some amount in your savings account. This is because it may take up to 2 days to get the redemption amount in your bank account.
      
• Use it for short term goals. If you are planning a vacation which is 3-6 months away then you can invest your money in liquid funds and redeem when needed.
      
• If want to have emergency fund than you can park a part of that fund in liquid funds. It is advisable to have some part of emergency fund in savings account and rest in liquid funds.
     
• Liquid funds are also good alternative to short term fixed deposits. They provide you with interest higher than that of fixed deposits and there is no lock in period. Also there is no penalty or exit load for liquid funds on pre-mature withdrawals.
     
• Another benefit of using liquid funds is that whenever there is a correction in the market you can switch your money from debt to equity.
      
• Last but a very important point, liquid fund comes with peace of mind. Capital protection is highest among all volatile assets and liquid funds are least sensitive to interest rate fluctuations among all debt funds.
     

Withdrawals from liquid funds

To withdraw from liquid fund you need to redeem the units of funds. This can be done online also. Withdrawals from liquid funds are processed within 24 hours on business days. Cut off time for purchase or withdrawal is 2 pm for liquid funds. It means if you place a redemption request by 2 pm on a business day (not on Saturday or Sunday or other non-business day), then the amount will be credited to your account on the next business day by 10 am. If you place it after 2 pm then it will take one more day to get the amount in your bank account. This way, redemption can take up to 2 days. 

Taxation on liquid funds

Liquid funds are taxed like any other debt funds. For more details you can read "Mutual Fund Taxation Rules". Therefore, if your are in highest tax bracket than Short Term Capital Gains from liquid fund or interest from fixed deposits will hurt you the most. 

However, there is tax efficient strategy that you can adopt. Dividends from liquid funds are tax-free in the hands of investor, which makes them more attractive than bank fixed deposits. In case you do plan to hold the investment in liquid fund for over three years (like for emergency funds); opt for the growth option to benefit from the indexation benefits.

Happy Investing!!!!