What Is a Liquid Fund? Understanding Its Purpose and Role Within Mutual Fund Investing

When it comes to mutual fund investing, not every decision revolves around long-term wealth creation. Sometimes, you may simply want to park surplus money for a short duration, perhaps while waiting for another investment opportunity, preparing for an upcoming expense, or maintaining an emergency buffer. In such situations, a liquid fund can serve as a suitable option.

Unlike equity or long-duration debt funds that focus on growth over several years, a liquid fund emphasises liquidity and relative stability. It allows you to access your money easily while seeking returns that may be potentially more suitable than those from a regular savings account. For investors who value flexibility and short-term parking options, understanding what is liquid fund and how it fits within a mutual fund portfolio can be helpful.

Let’s explore how these funds work, their potential benefits, and what you should consider before investing.

What is a liquid fund

A liquid fund is a type of mutual fund that primarily invests in money market securities and short-term debt instruments. These funds are designed to provide a level of income that aligns with the objectives of relative capital stability, lower risk, and high liquidity.

Liquid funds typically focus on instruments with a residual maturity of up to 91 days only. The portfolio may include treasury bills, commercial paper, and certificates of deposit that can be converted to cash.

These funds may be suitable for individuals and businesses managing short-term cash flows. They may also appeal to investors looking for alternatives to savings accounts or those seeking a temporary holding place for funds until they explore other investment opportunities.

Additionally, liquid funds may serve to build emergency reserves. For investors waiting to identify suitable equity or debt opportunities, liquid funds may offer a relatively stable place to park money.

Benefits of investing in liquid funds

Potentially better returns than savings accounts

Liquid funds may offer relatively better returns than traditional savings accounts* while maintaining relatively low risk. The short-term debt instruments they invest in tend to provide interest aligned with money market rates.

*Returns on savings accounts are fixed, however, returns on mutual funds are subject to market risks.

Past performance may or may not be sustained in future.

Relative stability of investment

By investing in highly rated instruments with short maturities, liquid funds aim to limit the impact of market fluctuations on the principal. This relative stability makes them suitable for short-term investments.

Cash management flexibility

Liquid funds provide easy access to cash, often allowing redemption within one business day. Features like Insta-Redemption (up to Rs. 50,000 or 90% of Redeemable Balance, whichever is lower) may help in meeting urgent expenses efficiently.

Versatility

If you are waiting for market opportunities in other asset classes, a liquid fund may serve as a temporary parking place for your funds. Using a lumpsum mutual fund calculator may help project potential returns for one-time investments.

Lower risk

Since liquid funds invest primarily in short-term, high-quality debt instruments, their risk tends to be lower than longer-duration debt funds or equity funds.

How liquid funds work

Liquid funds operate by investing in short-term debt and money market instruments with maturities of up to 91 days. Common instruments include:

• Treasury bills (T-bills)
• Commercial paper (CPs)
• Certificates of deposit (CDs)

The fund’s net asset value (NAV) reflects the market value of its assets after deducting liabilities. Professional fund managers oversee the portfolio, adjusting investments to maintain liquidity and stability. Investors can redeem units at the prevailing NAV, usually with quick settlement.

For illustrative purpose only.

Step-by-step process to invest in liquid funds

1. Choose a platform: You may invest through distributors, financial advisors, or direct AMC platforms online.
2. Complete KYC: Provide PAN, Aadhaar, and bank details for verification.
3. Select a fund: Evaluate different liquid funds, considering returns, ratings, and expense ratios.
4. Decide investment mode: You may choose lump sum or set up an SIP for regular contributions.
5. Invest: Complete the transaction through the platform. Units will be reflected in your account.
6. Track performance: Monitor your investment using dashboards provided by the platform.

Factors to consider before investing

• Liquidity: Check the average maturity of the fund’s assets to ensure it meets your cash access needs.
• Investment horizon: Liquid funds are generally suitable for short-term goals, typically under three months.
• Returns: While they may offer better returns than savings accounts, they are market-linked and not guaranteed.
• Exit load: Some funds may charge a fee for early redemption. Always review these terms.

Who should consider liquid funds

• Individuals with short-term surplus funds: Those who need money in the near term or are waiting for another investment opportunity.
• Businesses managing cash flows: To keep surplus funds accessible while earning potential returns.
• Investors seeking lower volatility: Compared to equity or long-duration debt funds.
• Alternative to savings accounts: Those looking for slightly better returns with market-linked risk.
• Temporary holding option: To park funds while exploring other investments.

Conclusion

Liquid funds may offer a suitable option for investors seeking high liquidity, relatively lower volatility, and short-term investment opportunities. While returns may be potentially higher than savings accounts, they are not fixed or guaranteed. Assessing your financial objectives, risk tolerance, and tax implications before investing is essential. Understanding what is liquid fund may help you decide whether it aligns with your short-term investment strategy.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

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