Liquid funds are open-ended mutual funds that invest in highly liquid money market instruments like treasury bills, certificates of deposit, commercial paper and corporate bonds. They are considered to be one of the safest investment options available as the risk is relatively lower compared to other mutual funds. Here are some key things you should know about best liquid funds to help you make an informed decision.
Money market instruments are short term debt instruments with high credit quality and maturity of less than one year. They include treasury bills, commercial paper, certificates of deposit etc. issued by banks, corporations and government. These instruments are considered to have very low risk of default and provide regular interest income.
Liquid funds work like any other mutual fund. When you invest in a liquid fund, your money is pooled with other investors’ money. The fund manager then invests this pooled money in highly liquid money market instruments. The NAV (Net Asset Value) of the fund keeps fluctuating based on the market value of the underlying investments. You can easily redeem your units anytime and get back the current NAV value in 1-2 working days.
Since liquid funds invest in low risk money market instruments, the returns offered are usually higher than bank fixed deposits but lower than other debt funds. The returns may vary between 6-7% annually depending on prevailing interest rates. Returns are declared daily but credited weekly, monthly or quarterly as per the plan opted for. Capital is not at risk but returns are not guaranteed.
The gains earned from liquid funds are taxed as per your income tax slab if redeemed before 3 years. If held for more than 3 years, gains are taxed at 20% with indexation benefit. Indexation benefit allows you to reduce the impact of inflation on your capital gains. Dividend received is tax free in the hands of the investor.
Liquid funds are ideal for parking emergency funds or funds that may be needed within 1-2 years. Since the investments are made in highly liquid instruments, you can easily withdraw money within 1-2 working days without much loss in value. This makes liquid funds a safer option than keeping funds in a savings account.
Liquid funds carry very low risk compared to other debt funds as the underlying investments have very short maturity and high credit quality. This makes liquid funds suitable even for risk-averse investors who want to earn higher returns than bank fixed deposits without taking high risk. Senior citizens can also consider liquid funds to generate regular income in a low-risk manner.
Liquid funds are a good debt mutual fund option for investors looking for low risk investments with better returns than bank fixed deposits. By understanding the key aspects of liquid funds and taxation of mutual funds, you can make an informed choice on whether they suit your specific investment goals and risk profile. Always consult a financial advisor before investing to get expert guidance suited to your unique needs.