Liquid Funds Explained 

A prudent financial plan not only requires a well-chalked out investment journey for the achievement of financial goals but also maintaining a contingency fund for any future emergencies. As such, an emergency corpus of at least six months’ expenses is always desirable, so that you can enough financial cushion towards any unforeseen situation. However, most of the households prefer to keep such surplus funds in bank savings accounts, the interest rate of which is 4% for the majority of banks. The Savings Bank Deposits increased from Rs. 28.84 lakh crores in FY17 to Rs. 30.97 lakh crores in FY18, occupying around 13% of the Individual Wealth in India (Source: Karvy Wealth Report 2018). This amount is even higher than the total mutual fund industry size. 

While the bank savings accounts help the investors with immediate liquidity, the lower yields make them an undesirable option to park their surplus funds. On the other hand, the investors may also consider investing in liquid funds, offering liquidity and convenience.  If you are wondering regarding what is a liquid mutual fund, this article aims to clear all your doubts in respect of liquid funds.

What are Liquid Funds?

Liquid funds refer to the specific category of debt funds which invest primarily in debt and money market securities with a maturity of up to 91 days only. Examples of such instruments can be treasury bills, Commercial Paper, etc. 

Benefits of Liquid Funds

Liquid funds provide the following benefit to the investors:

1. Potential of Better Returns – Liquid funds invest in money market instruments, which tend to offer better returns. Even the past performance of liquid funds category vouches for this, as it has generated average 6.94% returns for the investors over the past one year and further, 6.77% and 7.40% returns over 3-year and 5-year period respectively. (As on 26th June 2019) (Source: ValueResearchOnline).    

2. No Exit Load – Since liquid funds are offered for short-term money management, exit load may or may not be applicable on the liquid funds. As such, the investors can invest in liquid funds for any duration, which can be as low as one day even and still earn the returns for that period. Traditional investment products like fixed deposits offer interest only if the investment period is at least seven days. 

3. Liquidity – Liquid funds source their category name from the convenience of liquidity of the invested funds, as the redemption requests from liquid funds are processed faster than regular equity or debt funds. The cut-off time for liquid funds is 3 PM 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. 

4. Low Risk – Considering the residual maturity of the portfolio securities is less than 91 days, there is minimal impact of interest rate movements. As such, liquid funds carry low interest rate risk.  

Taxation of Liquid Funds

Similar to the treatment of returns from other debt funds, the realised returns from liquid funds are taxable as capital gains, wherein the tax rate is dependent upon the investment period. Short term capital gains (with an investment period of lesser than 36 months) are taxed at the regular tax rates applicable to the investor, 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. 

Why should one invest in liquid mutual funds?

Given the low risk, similar liquidity with a potential of better returns, the investors may consider parking their surplus funds in liquid funds, instead of keeping them in low-yielding savings bank accounts.

Disclaimers: The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is advised to consult his or her or their own tax consultant with respect to specific tax implications arising out of their participation in the Scheme. Income Tax benefits to the mutual fund & to the unit holder is in accordance with the prevailing tax laws/finance bill 2017. Any action taken by you on the basis of the information contained herein is not intended as on offer or solicitation for the purchase and sales of any schemes of UTI mutual Fund. Please read the full details provided in SID and SIA carefully before taking any decision.

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