Liquid funds: Quick money when needed

Thu Apr 5, 2012 2:24pm IST

An employee counts Indian rupee notes at a cash counter inside a bank in Agartala, December 31, 2010. REUTERS/Jayanta Dey/Files

An employee counts Indian rupee notes at a cash counter inside a bank in Agartala, December 31, 2010.

Credit: Reuters/Jayanta Dey/Files

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Liquid funds invest in money market instruments. While searching for different investment options, you might have come across the term ‘Liquid Funds'. There are many of us who might have wondered what these funds are and more so after the news articles popped up telling everyone that investing in these funds is not a smart choice. However, before we make a decision, let's discuss what Liquid Funds are.

What are Liquid Funds?

When we try and understand the term ‘liquid' in financial terms, it means an asset which is as good as hard cash. Real estate is the least ‘liquid' of all assets and a savings deposit is the most ‘liquid' of all. Similarly, Liquid Funds are a kind of mutual fund or debt fund which can be redeemed in as less as 24 hours.

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What are Liquid Funds invested in?

Liquid funds invest in money market instruments. Money market is a market for short term borrowing and lending. This market deals with debt instruments such as certificate of deposits, commercial paper and treasury bills.

What is the ‘lock-in' period for Liquid Funds?

Most funds have a lock-in period of a maximum of three days to protect against procedural (primarily banking) glitches, and offer redemption proceeds within 24 hours. However, some funds may even have a lock-in period of a week or a month or more. However, the tenure is always far less than a normal mutual fund.

What are its features?

1) No entry and exit load (sometimes exit load is charged if redeemed before the lock-in period)

2) Low annual fee 0.30 to 0.70%

3) Variable minimum investment amount according to scheme

4) Great tax benefit

5) Easy liquidation, hence the name

6) An average 8% p.a return on liquid funds

7) Liquid funds have the restriction that they can only have 10 per cent or less mark-to-market component, indicating a lower interest rate risk.

What are the tax benefits?

If you invest in a short-term fixed deposit, the returns are taxable as per the investor's tax bracket. Therefore, if you are in the highest tax bracket most of your returns from the fixed deposit would be wiped out.

On the other hand with liquid funds, as mentioned before, if the dividend option is taken, the returns are tax-free in the investor's hand.

Has the past performance been good?

In the last one year, liquid funds have returned between 7.7 per cent and 8.85 per cent. Recent data shows that banks are taking fresh exposures in liquid funds which indicates a high degree of safety and confidence in liquid funds. This shows that liquid funds are a good product to invest in if you are looking to fulfill some short-term goals.

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