A liquid fund is an excellent option to invest or keep money for a short period of time. Such as when the funds will be necessary within weeks or months. This type of fund is useful for instances where money may be needed quickly. As with other forms of mutual funds, there is a possibility of losing money when investing in liquid funds. But because of how these funds operate, investing in them is preferable to placing money in a fixed-term financial instrument to receive short-term income. Let us understand meaning of liquid funds with examples, types, benefits and limitations of it.
Compare with equity funds for better understanding of the topic. The fund allows investors to withdraw their money at any moment, including the day after their initial investment. This means that they are able to gain accretion daily. In contrast to most other products, taxes are not deductible at the source when liquid funds are cash in. If you invest for at least one week, you will likely not have to pay the exit load, which is a cost that you must pay if you sell your shares of a mutual fund early. This reduces the out-of-pocket expenses typically involved with purchasing shares of a mutual fund.
Meaning of Liquid Funds
Liquid funds are a subset of debt mutual funds that invest predominantly in short-term market instruments such as Treasury bills, commercial papers, government securities, and certificates of deposit. Due to the fact that the funds in these accounts are invested in assets with maturities of up to 91 days, investors can feel comfortable leaving their funds there for shorter time periods (one to three months).
If an investor has excess cash but anticipates needing it within the next several days, weeks, or months, they should strongly consider investing in liquid mutual funds. There are various types of debt funds, but liquid funds are consider the most secure and risk-free option. This is due to the fact that the great majority of their holdings consist of products with high credit ratings.
If a mutual fund scheme can only invest in debt and money market securities with maturities of 91 days or less, the scheme belongs to the “liquid funds” category. These funds invest in less-than-91-day-old debt assets such as T-bills, commercial paper, certificates of deposit, and bank term deposits. Additionally, Treasury bills are a form of short-term debt security.
Types of Liquid Funds
Before you begin investing, you should ensure you have a thorough understanding of liquid funds and how they operate. Despite the fact that liquid funds may fulfil the demands of some investors, those who wish to construct a more traditional investment portfolio should avoid them. If you choose to invest in liquid funds, you should be aware of the following information. Investing in these funds requires knowledge of the following types of liquid funds:
Treasury Bills (T-bills)
The Indian government issues one-year Treasury Bills (T-bills), which are short-term debt instruments. Because they are back by the full faith and credit of a sovereign nation, these securities offer a very high level of security. In comparison to other securities and the risk-free rate, T-bills offer an extremely low rate of return.
Certificate of Deposit (CD)
CDs are term deposits, similar to fixed deposits. The banks on the Federal Reserve’s list provide these services. The primary distinction between certificates of deposit (CDs) and fixed deposits (FDs) is that CDs do not permit early withdrawals.
Commercial Paper (CP)
Typically, businesses and other financial institutions with strong credit ratings issue commercial paper. Commercial papers are discounted, unsecured, redeemable at face value securities. These sorts of securities are comparable to promissory notes in many aspects. Profit is the amount of money remaining after all expenses have been deductible.
Benefits of Liquid Funds
If you work in the financial industry and require a short-term investment vehicle, you may choose to investigate liquid mutual funds. The objective of these liquid mutual funds is to provide investors with as much security as possible while also maximizing their returns. Here are some of the benefits of liquid funds are mention below.
Reduced Risk
All of a liquid fund’s assets are invest in bonds issued by reputable government entities. Due to this, there is a low likelihood of getting wounded. In addition, because they are debt instruments, they have the reputation of always returning principal and interest to their owners.
Having Sufficient Cash Flow in and out
These funds are ones that have a low probability of defaulting and can be redeem immediately. Typically, you have no more than one day to redeem an item. Due to this, there is a great deal of money that can freely circulate in these types of funds.
Rapidly Redemption of Liquid Funds
To put it another way, the investor may sell the assets whenever he desires prior to the maturity date. If he withdraws from the programme within the first week, he must pay a nominal charge to receive a refund.
The price is reasonable.
Regarding investments of this nature, the expenditure ratio is usually invariably below 1 Percent. Due to the efficiency of their cost structure, they are able to provide investors the maximum rate of return permitted by law. These funds are high-security debt products, are the way to go if you wish to recover your investment capital.
Profit Increases During Inflation
Due to this, liquid assets are also an excellent option when inflation is high. [Requires citation] The Reserve Bank of India (RBI) raises its interest rate to lower the amount of money in the market when inflation is high. This is done to prevent price fluctuations. As a result, this facilitates the maximization of readily available funds.
Limitations of Liquid Funds
This is an excellent method for making short-term deposits because the benefits are modest but the danger is relatively low. Once we’ve discussed the advantages of liquid money, we can move on to their potential limitations of liquid funds.
Exit Load of Liquid Funds
There is no minimum holding period, but a “exit load” cost applies if the investment is sold prematurely. If investors withdraw their funds from the plan within the first week, they will be chargeable. However, it is crucial to highlight that these fees are typically unobtrusive and do not interfere.
Low Returns
When you invest in a liquid fund, you often receive a lower return than you would with more lucrative investments. This is one of the most important reasons why you should not invest in a liquid fund. Consequently, investors that chose liquid funds for their portfolios miss out on the opportunity to earn substantial returns by investing in high-return funds.
Conclusion
Because regulatory bodies impose stringent criteria on the underlying investments of these types of liquid funds, their portfolios are very liquid. Therefore, they are an excellent option for short-term investments. Due to the fact that liquid funds do not have a fixed maturity date, they are preferable for investors with a flexible time horizon and provide the possibility of larger returns. Fixed-term, fixed-return debt investments, on the other hand, have both a fixed return and a fixed term.