If you have some money sitting idle with you with no immediate requirement but can not invest it for a longer duration, then liquid funds are a perfect solution for you.
Table of Contents
What are the Liquid Funds?
Liquid funds are a class of debt mutual funds or debenture through which investments are being done predominantly in high-quality fixed instruments that mature within 91 days. Liquid funds invest in short-term fixed-interest generating money market instruments like Certificate of Deposits, Treasury Bills, Commercial Papers, and Term Deposits.
A Debenture is nothing but legal contractual papers issued by the government or Firms to the investor, which serves as a certificate to pay the investor back the amount, with a fixed rate of interest in the pre-decided interval. Sometimes it is also called a Bond but it has some important differences from bonds.
Why any organization or government will repay with interest?… because both the company and Government require money for their future expansions and long-term plans to execute. The fund required for the same may be acquired in many ways and one of the ways is to take loans or debt from the persons who are willing to invest with the firm in hope of generating a return in the future. So in the case of debenture, organizations borrow money from lenders and repay them the money borrowed with fixed interest. So, it is somewhat like Fixed Deposits where the investor will be paid back the money invested with interest.
There are different types of Bonds floated in the market depending on the maturity period or the time for which money is borrowed by the organization. Short-term Bonds may mature in days or weeks while it takes to up to 20 years for Long term bonds to mature. Usually, long-term bonds are issued by the Government while Short term bonds are issued by both Government and Organisations.
The thing to remember here is that we must buy the product which matches our needs and time period of investment. It means, if we need the money back after one year then we must go for short-term bonds and if we do not want money shortly then we can go for long-term bonds. So if we are investing in the organization, then why we are taking a Mutual Fund, when we can go for purchasing a bond directly from the company?
What is the need for Liquid Funds?
Actually, investors do the same in the form of Company Deposits and purchase the bonds directly from the firm. But we do not have enough exposure to the market system and can not track the future of the company. So better this task be handed over to a qualified person who is well versed with the market system and can predict the future and generate a return for you to whom we term as Fund Manager.
Also if you are picking the company on your own then you may be picking debt papers or bonds of limited companies, and if the market tumble then the loss of investors will be in the same proportion. But in Mutual Fund, Fund Manager keeps many firms in one basket, so that if at all one or two firms show negative returns during a market fall, other firms will significantly generate good returns. So Fund Manager generates positive returns by keeping no of products in one basket which is called diversification of the portfolio.
Type of Debenture Mutual Fund
Debenture mutual funds are classified based on the maturity period and the quality of the paper issued by the fund. If you are carrying good quality bond paper (i.e bonds of the reputed company) in your basket then the return will be lesser. But if you want your money to be associated with minimal risk then go for high-quality papers.
Liquid Fund Basics
Liquid fund is a category of Debenture Mutual Fund in which your money will be invested mostly into money market tools like Certificates of Deposits, Treasury Bills, Commercial Papers, and Term Deposits. The maturity periods of these types of Funds are usually an average of 3 months (the holding period of this fund is 3 months on average). The fund Manager finds it easy to cater to the immediate redemption requests by investors through this fund.
As per new guidelines issued by SEBI, you can request redemption of up to Rs 50,000 a day from your liquid fund or 90% of your money in your liquid fund whichever is lower. If you have invested in more than one liquid fund then you can place a request for redemption equal to the money multiplied by the number of liquid funds you are holding. The liquid fund invests in Debenture mutual fund so there is very minimal risk associated with them and you can be almost sure that your capital is safe.
Articles to enhance your knowledge further:
- Why investing in mutual funds are safe?
- Systematic Investment Plan (SIP) – Why it is best for you to invest?
Benefits of liquid funds
⇒ These types of debenture Mutual Funds have no lock-in period means the company does not demand your money to be kept invested with fund houses for the defined term. So you can withdraw your fund anytime. Withdrawals are processed within 24 hours on business days and you can place a request for withdrawal up to 2 PM on business days. The money will be credited back to your account by 10 AM the next morning i.e within 21 hours.
⇒ Lowest interest rate risk among debt funds as they primarily invest in fixed-income securities with a short maturity.
⇒ No Entry load and exit loads are associated with the redemption of liquid funds.
⇒ Liquid funds are best in terms of high returns with short-term maturity.
Ultra Short-Term Funds
There is another type of Debenture Fund in which the maturity period of the bond is from 3 to 9 months. These Bonds invest in securities that have a maturity period of up to 18 months as well. This type of fund can be seen as very close to the liquid funds with maximum liquidity with minimum risks associated with it but you have to constantly track it for the performance of funds. A Triple AAA rating is the safest kind of bond u can buy, whereas Double BB means a fairly high level of risk so it is usually safe to stay with large funds.
Ultra short-term funds can be used by investors for both short-term and long-term investment purposes or else can go for systematic transfer plans (STPs) in place of liquid funds. These types of debenture mutual Funds usually give a return of about 7-9% provided all other conditions are met. The thing to note here is that Fund house charges a fee from investors called Expense Ratio which may be up to a maximum of 1.05 % of the total investment.
Also, the returns generated over the investment in these funds are taxable and the rate of the tax depends on the time for which you invested. STCG is applicable for the investment made for less than 3 years while LTCG is for the investment made over 3 years. One major mistake we do while investing in Mutual Funds is that we start hoping for the Long Term Funds to generate returns over Short Term which is not possible with market volatility.
Other Debenture Funds based on duration are:
| Name of Fund | Maturity Period |
| Overnight Funds | 01 Day |
| Low Duration Fund | 06 to 12 Months |
| Money Market Fund | Up to 01 Year |
| Short Duration fund | 01 to 03 Years |
| Medium Duration Fund | 03 to 04 Years |
| Medium to Long Duration Fund | 04 to 07 Years |
| Long Duration Fund | Above 07 Years |
| Dynamic Bond | Investment across Duration |
Other Miscellaneous Funds
Corporate Bond Fund – Minimum Investment in Corporate Bonds is @ 65%, the highest rating is AAA rated
Credit Risk Fund – Minimum Investment in Corporate Bond is @ 65%, the Highest rating is AA rated
Banking and PSU Fund – Minimum Investment in Banking and PSU Debt fund @ 80 %
Gilt Funds – Minimum Investment in Government Securities @ 80 %.
Please note down that Debenture Funds are not Risk-Free. Credit risk funds are also a type of Debt Mutual fund that invests 65 % of their portfolio in lower than AA-rated papers. This means these schemes opt for generating high returns by taking higher credit risk. Lower-rated papers generate high returns when their ratings move up. If a bond with a lower rating in the portfolio downgrades, it may be difficult for the Fund Manager to exit the investment.
Conclusion:
If you have some money sitting idle with you with no immediate requirement but can not invest it for a longer duration, then liquid funds are a perfect solution for you. Here, you can earn some extra income over that money by parking them into the various liquid funds. The only thing you must note is that you should at least keep that money for the pre-specified period in that fund and not withdraw it before maturity.