It is advisable to maintain a contingency fund for any future emergencies. The quantum of such a contingency fund is relative to different individuals depending on their committed payments, lifestyle expenses, etc.
However, as a generic measure, one should maintain a contingency fund equivalent to cover expenses for the current lifestyle for at least six months to have a sufficient financial cushion. Most people park their emergency funds in savings accounts because of liquidity and nil market-linked risks, however, they may offer interest as low as less than 3%.
Liquid funds on the contrary, may yield better reasonable returns as they invest primarily in debt and money market instruments of up to 91 days residual maturity. Since the investments are in short-term papers, interest rate risks are much lesser in these funds. They also offer reasonably good liquidity and convenience, making them a preferred alternative for parking surplus funds.
What are liquid funds?
Liquid funds are a category of debt funds that invest primarily in debt and money market securities with a maturity of up to 91 days only. Accordingly, such funds may invest in Treasury Bills (T-Bills), Commercial Papers, Certificate of Deposits, Government Securities having residual maturity of up to 91 days, etc.
Benefits of liquid funds
Potential for better returns
Liquid funds invest in debt and money market instruments and may offer reasonably good returns. Professional fund management for the invested money can further equip the investors with the potential for better returns.
No exit load for an investment of seven days or more
If the investor has invested in liquid funds for seven days or more, no exit load is levied on the redemption. For investments with a holding period of fewer than seven days, a graded exit load is charged, which reduces as the holding period increases and becomes zero on the seventh day of holding investments.
Liquidity
Liquid funds are named so on account of the liquidity of the invested funds, as the redemption requests from liquid funds are processed faster than regular equity or debt funds. Any redemption request placed before the cut-off time on a working day is processed for redemption credit to your bank account on the next working day.
Low risk
Considering that the residual maturity of the portfolio securities is up to 91 days only, there is a minimal impact of interest rate movements. As such, liquid funds carry insignificant interest rate risk.
Given the convenience of investing in liquid funds, liquid funds occupy the lion's share of open-ended debt funds' overall AUM (Assets Under Management). Liquid funds represent around 30% of the total assets of open-ended debt funds and 10% of all the mutual fund schemes with an AUM of Rs. 3.64 lakh crore as of June 30, 2022.
Source: Association of Mutual Funds in India – AMFI
However, a significant chunk of this AUM comes from institutional and corporate investors, which use liquid funds to park their short-term surplus funds.
How to invest in liquid funds?
The process to invest in liquid funds is not different from investing in other mutual fund schemes. Thus, the investors can invest in liquid funds by physically submitting the application forms at any Official Point of Acceptance (POA) for the mutual fund house or the Registrar & Transfer Agent (R&TA).
Further, an investor can also undertake the transaction through digital means, i.e., through the website/mobile app of the mutual fund house or R&TA. Such investment can be made in a lump sum or through a Systematic Investment Plan (SIP). If one has registered a SIP, the investment amount is deducted automatically from the bank account on a specified date and invested in the specified mutual fund scheme. As such, SIP enables investors to make regular and consistent investments.
Taxation of liquid funds
Similar to the treatment of returns from other debt funds, the realized returns from liquid funds are taxed as capital gains, wherein the tax rate depends on the investment holding period. Short-term capital gains (with an investment period of fewer than 36 months) are taxed at the regular tax rates (plus applicable cess and surcharge), while long-term capital gains (where the investment period is 36 months or more) are taxed at 20% (plus applicable cess and surcharge) with indexation benefits.
Indexation adjusts the acquisition cost for inflation prevailing over the investment period while calculating the taxable gains, thus taxing only inflation-adjusted returns. Given the low risk and similar liquidity with a potential for better returns, investors must consider parking their surplus or contingency funds in liquid funds.
Note: The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2022 presented in the Parliament in February 2022. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the investment date.
Disclaimer-
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
To know about the KYC documentary requirements and procedure for change of address, phone number, bank details, etc. please visit https://www.utimf.com/servicerequest/kyc. Please deal with only registered Mutual funds, details of which can be verified on the SEBI website under "Intermediaries/market Infrastructure Institutions" All complaints regarding UTI Mutual Fund can be directed towards service@uti.co.in and/or visit www.scores.gov.in (SEBI SCORES portal). This material is part of Investor Education and awareness initiative of UTI Mutual Fund.
