It is always advisable to hold an emergency fund corpus to meet any life contingencies. Such emergency fund should be equal to at least six months' regular expenses one needs to incur, for it provides sufficient financial cushion for any unforeseen situation in life. While maintaining an emergency fund is often on the agenda of many households, many savers keep such funds in the traditional savings accounts.
While such traditional options help investors with immediate liquidity, the lower interest rates on such accounts make them unattractive to park their surplus funds. The current interest rates on savings accounts offered by different banks start from 2.75% per annum. Instead, the investors may consider investing in liquid funds to for better alternative to these options.
Liquid funds invest primarily in debt and money market securities with a tenor of up to 91 days only. Examples of such instruments can be Treasury bills (T-Bills), Commercial Paper, Certificates of Deposit, etc. Liquid funds render several benefits to the investors, some of which are as below:
Potential of Better Returns
Liquid funds invest in debt and money market instruments, thereby having higher probability of generating better returns than traditional savings accounts. Professional fund management for the invested money can further help the investors maximise their returns.
Liquidity
Liquid funds derive their nomenclature from the easy liquidity such funds provide to the investors. The turnaround time for redemption requests from liquid funds is lesser than regular equity or debt funds.
The cut-off time for liquid funds is 1.30 PM for purchase and 3.00 pm for redemption of units, and any 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. Some funds also offer an instant access facility for such funds, wherein the redemption proceeds are credited instantly to the bank account, subject to a maximum daily limit of Rs. 50,000 or 90% of the fund value.
No Exit Load for an investment of 7 days or more
If the investor has stayed invested in liquid funds for seven days or more, no exit load is levied on the redemption. A graded exit load is levied for investments for less than seven days, which reduces as the holding period increases and becomes zero after seven days.
Low Risk
Since the tenor of the portfolio securities will always be up to 91 days only, there will be a minimal impact of the interest rate changes on the portfolio valuation. As such, liquid funds carry comparatively lower interest rate risk. Further, the investment is made predominantly in sovereign securities and high-rated debt securities. As such, the credit risk and liquidity risk for such funds are also lower.
Given the convenience of investing in liquid funds, liquid funds occupy the lion's share amongst open-ended debt funds' overall AUM (Assets Under Management). Liquid funds represent around 25% of all the open-ended debt funds with an AUM of Rs. 3.71 lakh crore as of August 31, 2021
However, a significant chunk of this AUM comes from the institutional and corporate investors who use liquid funds to manage short-term surplus funds.
Source: Association of Mutual Funds in India – AMFI
Taxation of Liquid Funds
Like other debt funds, the returns from liquid funds are also taxed as capital gains once the profits have been realised on redemption of mutual fund units. The tax rate on such capital gains is dependent upon the holding period for such investments.
The gains from investments held for less than 36 months are classified as Short-Term Capital Gains (STCG), and investments held for 36 months, or more are classified as Long Term Capital Gains. STCG is taxed at the regular tax rates applicable to the investors, while LTCG is taxed at 20% with indexation benefit.
Given the low risk with the potential of better returns and easy liquidity, the investors may consider investing in liquid funds for parking their emergency corpus.
Note: The tax provisions, as mentioned in the article, are for illustrative purposes only and are updated as per the Union Budget 2021 passed by the Parliament. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.
