Unlocking the potential of liquid funds: The ultimate guide to short-term investing
In personal financial planning, short-term investments serve as an important vehicle for achieving liquidity, stability, and desired returns. Among the number of mutual fund investment available, liquid funds offer a viable option for those seeking to park surplus funds for short durations due to their stability and liquidity. In this comprehensive guide, you will understand the intricacies of liquid funds, their working, benefits, and essential considerations for smart investment decisions.
What is a liquid fund?
Liquid mutual funds are a type of open-ended debt mutual funds that primarily invest in short-term money market instruments such as treasury bills, commercial papers, and certificates of deposit. These funds are designed to offer investors a high degree of liquidity and relatively stable returns over the short term, typically ranging from a few days to a few months.
How does a liquid fund work?
Liquid fund function by pooling funds from multiple investors and deploying them into a diversified portfolio of low-risk debt instruments with short maturities. The underlying assets in a liquid fund are highly liquid, allowing investors to redeem their investments quickly and conveniently, often within 24 hours. Moreover, the NAV (Net Asset Value) of liquid funds remains relatively stable, reflecting minimal fluctuations in short-term interest rates and credit quality of the underlying securities.
What are the parameters to choose a liquid fund?
Expense ratio: The expense ratio of a liquid fund represents the annual fees charged by the fund house for managing the fund. Opting for funds with lower expense ratios can enhance your overall returns, especially in the case of short-term investments where every basis point counts.
Liquidity: Evaluate the liquidity profile of the fund by examining the average maturity of the portfolio. Shorter average maturity implies higher liquidity, allowing for easier redemption of investments without significant interest rate risk.
Past performance: While past performance is not indicative of future results, analysing the historical performance of a liquid fund can provide insights into its ability to deliver consistent returns and withstand market fluctuations.
Fund house reputation: Consider investing in liquid funds offered by reputable fund houses with a proven track record of prudent fund management and adherence to regulatory guidelines.
Things to consider before investing in a liquid fund
Investment horizon: These funds are ideal for parking surplus funds temporarily, typically for periods ranging from a few days to a few months.
Risk appetite: Evaluate your risk appetite and investment objectives before allocating funds to liquid funds.
Tax implications: Since these are type of debt asset classes, investments held in liquid funds are subject to capital gains tax at the by adding it to individual's overall income and taxed at applicable tax slab rate.
Exit load: Opt for funds with minimal or no exit load to maintain flexibility in managing your investments.
How can you invest in liquid funds?
You can invest in liquid funds through two primary methods: lump sum and Systematic Investment Plan (SIP). In lump sum investments, you can allocate a single, large sum of money into the fund, providing immediate exposure to the chosen liquid fund. An SIP investment involves regular contributions at fixed intervals, such as monthly or quarterly, allowing for disciplined and systematic investing.
You can utilise SIP calculator to estimate potential returns and evaluate the impact of systematic investment plans on your investment portfolio. SIPs enable disciplined investing by allowing investors to contribute fixed amounts at regular intervals.
Conclusion
Liquid funds present a compelling investment avenue for individuals seeking to optimise returns on surplus funds while maintaining liquidity and capital preservation. However, it is imperative to tailor your investment decisions to align with your specific financial goals, risk tolerance, and investment horizon. With diligence, liquid funds can serve as a valuable tool in achieving financial stability and growth.
Disclaimer: This article is published in association with Nippon India Mutual Fund and not created by TNM Editorial.