The rate of interest on savings account deposits in banks has dipped by 50 basis points and is now 3.5 percent. Hence, may financial experts are suggesting investors to turn their investments to ultra short term liquid funds to get better returns.
Liquid Funds: what are they and when to use them?
Liquid funds are debt-based mutual funds which use the money of investors to invest in very short term securities and market instruments like government securities, treasury bills, and call money, etc.
The investments of liquid funds can consist of instruments that have a maturity period of up to 91 days. Such funds are typically used for parking the money of investors for a short time period, usually 1 to 3 months. For instance, if you want to improve your savings for a vacation that you want to take in a couple of months, or if you want the money saved for your child’s college tuition due in some months to yield returns, then you can park such savings in a good liquid fund.
Another use of liquid funds can involve situations when you suddenly get a bulk amount of money, such as in case of sale of property, or big bonus at work, etc. Investors can use such extra cash to invest in liquid funds while you look around for varied investment options. There are several equity MF investors who use liquid funds to diversify their investments in equity MFs via the STP or systematic transfer plan; this is done as investors believe that such a strategy can help get higher returns.
Rate of returns on liquid funds and redemption time frame
The data available on different financial and investment websites shows that the liquid funds category gave a return of over 6.5 percent in the last 1 year. This is nearly double the return as compared to the 3.5 percent interest rate on savings account deposits offered by most banks.
Investments in liquid funds can be easily redeemed and the money gets transferred to the linked bank account in the next business day. AMCs do not levy any exit or entry load on liquid funds.
What kinds of risks are associated with Liquid funds?
In the category of investments in mutual funds, liquid funds are regarded as the least risky and the least unpredictable/volatile. This is due to the fact that liquid funds typically have investments in instruments with a P1+ high credit rating. The net asset value or NAV of such funds rise/fall only to the extent of the accrued interest income, which includes weekends.
Difference between debt funds and liquid funds
As compared to different types of debt funds, liquid funds are unique with regards to application of NAV. For investments till 2 in the afternoon on a specific day of transaction (subject to availability of funds for use by 2 PM), the units get allocated on the NAV of previous day.
Liquid funds are thus the only category to receive the NAV of previous day. For redeeming liquid funds up to 3 in the afternoon on a specific transaction day, investors can redeem the units at the NAV of the same day and the monetary proceeds get credited to the account in the morning of next day.