Investing in Liquid Mutual Funds :

Have you ever thought of getting an interest rate up to 9- 10% with such an investment which is as liquid as a saving bank account? Usually this much interest rate is offered by an investment with fixed tenure, so we don’t expect it in a savings account or any liquid investment. But, this is possible if we invest in a liquid mutual fund.
 

What is a liquid fund?

Liquid fund is a kind of debt fund which offers both high degree of liquidity and attractive returns. Liquid funds provide returns prevailing in the market as they invest in money market securities, such as Commercial Papers, Certificate of Deposits, Treasury Bills etc, for 1 to 91 days only. The shorter tenure of their portfolio makes them a safer investment and less sensitive to interest rate fluctuations, compared to other debt funds. These characteristics make liquid fund an ideal option for investors to park money compared to ultra short term fund and even short term fund.

Operating features of liquid fund

Let us know more about liquid funds before investing in it:

• The minimum investment used to be Rs. 5000, but it varies from scheme to scheme. It may be as low as Rs. 1000 or as high as Rs. 1 lakh.
• Liquid funds don’t lock money even for a single day.
• Liquid funds usually don’t have any exit load.              .
• These funds offer redemption proceeds within 24 hours. If you have submitted redemption request before 3 p.m., the amount will be credited to your bank account by just next day.
• Some of the mutual fund companies are offering new facilities with liquid schemes like ATM for instant withdrawal and transactions through sms.
   

Uses of Liquid Fund

There are various instances where liquid funds prove themselves suitable investments. Some of these are following:

• Usually, we all keep a good amount of fund in our savings account as liquid money. Though savings account is a must for all of us, it’s better to maintain the emergency fund in a good liquid scheme to avail benefits of good return with almost same safety and liquidity.

• If you have some surplus fund and yet not decided how to use it or where to invest it, park the fund in the liquid fund and withdraw when you have planned for it.

• If any of your investment is ready to cash in and there is a near term cash outlay, invest the proceeds in a liquid fund till the moment you need it.

• Liquid funds are useful if you want to benefit from interest rate movement. If you have some liquid money to invest in debt instruments and you are anticipating upward direction in interest rate, invest the money in liquid fund till the interest rate rises. If invested in liquid funds, your money earns at prevailing market rate. As soon as interest rate increases, withdraw your liquid fund investments and invest at higher rate of interest.

• When you review your portfolio, you may need to relocate some of the assets. In this process liquid funds are a perfect option to park the proceeds whenever your money is idle while reviewing and repositioning.

• You can use liquid schemes through Systematic Transfer Plan and switch transactions of mutual funds. These options will help you move your investments between equity and liquid (& other debt) schemes according to market scenario and personal needs.

• Liquid funds are beneficial during retirement phase. Retired persons prefer to have a handsome amount of money liquid. They can opt for liquid funds according to their comfort level. 
   

Taxation
Liquid funds attract capital gains tax. If withdrawn before one year, the profit is added to the income of the investor. Tax rate is according to his income tax slab. If withdrawal is made after one year, liquid fund’s taxation gives indexation benefits. Investor has to pay 10% tax without indexation and 20% with indexation on capital gain.

How to select a good liquid fund

Following are a few important points to consider while selecting a good liquid fund:

Corpus Size: As on 31^st March, 2013, 80% of AUM of liquid funds was invested by corporate. Retail investors hold a very small percentage of assets of liquid funds. Therefore, in a small-sized liquid fund, if a corporate investor redeems its money, it reduces fund’s corpus and affects the retail investor in an adverse way. So, it is always better to prefer large-sized liquid funds.

Portfolio Composition: The fund discloses its portfolio in its factsheet. Watch whether it has invested in good rated instruments and has a diversified portfolio.

Average Maturity Period: The fund’s factsheet also informs the average maturity period of the schemes. Check whether your investment horizon matches with the liquid scheme’s average maturity period.

Facilities Offered: Now-a-days, some mutual funds are offering innovative facilities such as ATM and transactions through sms. Apart from their good customer service, these facilities must get considerations while selecting a scheme because of ease of transaction which matters much in case of liquid funds. So explore them before selection.

Liquid Plus Funds

Liquid plus funds are also short term investments which invest in securities of a longer maturity period compared to liquid funds, i.e. more than 90 days. If your idle money has to be invested for a bit longer period, they are better option than liquid funds. However, they are also little riskier than liquid funds.

Conclusion

Liquid Funds are definitely a great way to make your idle money earn some decent returns along with sufficient liquidity.
Source :investmentyogi