Liquid Mutual Funds: All that you should to know

In this article, we have explained Liquid Mutual Funds. You will get answers to questions like – Who should consider Liquid Funds? Are they safe? Do they earn better returns than savings bank or fixed deposit accounts? What is the taxation for liquid funds?
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Liquid Mutual Funds are a type of debt mutual funds that invests in very short-term, highly liquid debt instruments such as treasury bills, commercial papers, and certificates of deposit. These instruments typically have a maturity of up to 91 days. Liquid funds earn returns in the form of interest income on the investments made in these debt instruments. 

Who should consider investing in Liquid Funds?

Liquid funds are preferred by investors to park their surplus money for short periods of time typically a week to 3 months. Individual investors can consider investing a portion of their emergency fund in liquid funds or take the Systematic Investment Plan (SIP) route to build an emergency fund over time. Institutions also find liquid funds attractive to park surplus funds as current account does not earn interest. Liquid Funds are also ideal for parking any sudden influx of money received from either sale of property, start-up funding, bonus or variable pay, the utilisation of which is undecided. Liquid Funds are also used to stagger the investment in equity funds by way of Systematic Transfer Plan (STP) to get the best out of volatile nature of the equity market. 

Are Liquid Funds Safe?

Liquid funds are required to invest in high-rated instruments which are considered to be having very low risk of default. Though there is no assurance on the capital safety, the stringent regulations on where the fund can invest works as a level of safety net. 

How are returns from Liquid Funds taxed?

The returns from liquid funds are taxed as capital gain as per the prevailing taxation* from time to time. Taxation comes into picture only upon withdrawal. 

*Please refer to the prevailing capital gain tax for debt fund to know the applicable taxation.

Do liquid Funds earn better returns than Savings Bank A/c?

Liquid Funds can earn better return than SB a/c during periods when the REPO rates (rate at which RBI lends money to Banks) are higher than the savings bank interest rates and/or when the short-term rates are high due to various reasons. 

Are Liquid Funds better than Fixed Deposits?

A direct comparison may not be apt. However, liquid funds offer more flexibility as there is no fixed maturity, no withdrawal penalty (above 7 days), nor a necessity to renew it periodically as compared to fixed deposits. On the returns front, fixed deposits lock the interest rate as on the date of investment whereas the liquid fund returns vary basis the average interest rate of its invested securities and also on the changes in the short-term interest rates (resulting in capital appreciation). 

What are the other benefits of investing in Liquid Funds?

A lot of individuals leave a sizeable amount of money in savings bank accounts. Many a times such money is hardly touched for years together. Moving a portion of it can help to earn a little better return (except for scenarios of low REPO rates). Also, many a times what is not seen in hand is often not spent. Investing the surplus short-term funds can help you avoid impulse spending.

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