Do you have the extra cash in your pocket but do not want to keep them in fixed deposits? You can then look for options like liquid mutual funds instead of holding a significant amount in your savings bank.
In the current high-interest rate scenario, liquid funds can work better than a savings account if you want to earn a little while keeping your money. The average return for liquid funds in the previous year was 9.3 percent. That is similar to fixed deposit rates.
What are they- liquid mutual funds?
Liquid funds are primarily debt-to-mutual funds that invest your money in very short-term market instruments such as treasury bills, government securities and call money that hold the least amount of risk. Such funds will invest in the instrument for a maturity period of 91 days. Maturity is much less than this.
They are less risky and less volatile in the category of mutual funds, for the following reasons:
- Mutual funds mainly invest in high credit rating (P1 +) instruments.
- Unlike other investments, liquid funds’ NAV is not volatile because the only adjustment of their NAV is mostly due to the interest income that it earns.
In other words, these securities are rarely traded on the market due to their short term maturities. They will hold until maturity is reached. Therefore, the range of interest income earned in their NAV, including weekends, changes daily.
Unlike ultra-short-term funds
Another type of short-term debt fund, which is also ideal for a short-term investment, is called ultra-short-term funds. But these are one notch higher than liquid funds on the risk chart. That is because ultra-short-term funds can invest in securities with a maturity of more than three months in the short term. Such instruments can also be traded in the market. Therefore, in response to market moves, the NAV may swing, making it slightly more volatile.
Exit load and dividend distribution tax (DDT) are two other significant differences between liquid funds and ultra-short-term funds. Liquid mutual funds do not suffer from an exit load, although some ultra-short-term funds may pay for exit immediately after investing them (exit times may vary from one fund to another). Liquid funds spend a DDT of 27.04% (including surcharge and cess at the beginning of AMC), but only 13.52% for ultra-short-term funds.
When to choose- liquid funds
If you have sudden cash flow, then liquid funds are the perfect parking space, because you got money from a legal settlement or investment maturity. It is worth remembering that liquid funds may not be a complete option for a savings bank account. Except for some investments, you cannot withdraw money immediately (as you do at ATMs).
Given the low-interest rates in the savings account (mostly around 4% and 6-7% for one or two banks); you will be able to temporarily put your funds into liquid funds to get slightly higher interest rates. Without an exit load, you can opt-out of the plan at any time and receive your money the next day.
Another way to use liquid funds is to invest in your lump-sum receipts and then opt for a systematic investment plan to invest in your preference of equity funds. You often use SIP to invest in equity funds. That is fine when you invest outside of your monthly savings. But if you get a large amount at one go, in such situations, you can use liquid mutual funds to increase your returns.
If your holding period increases to three months – say 6–9 months or more – then you can consider going for ultra-short-term funds. Invest in these funds once because you do not need to think about the timing of the market. Not all liquid funds have SIP options.