COMPLETE GUIDE TO LIQUID FUNDS (2024)

FAQs

How long can I keep money in liquid funds? ›

Liquid funds are preferred by investors to park their money for short periods of time typically 1 day to 3 months.

Liquid funds are considered to least risky among all classes of debt funds as they mostly invest in high-quality fixed-income securities that mature soon. Therefore, these funds are suitable for risk-averse investors.

As per the data from Value Research, many large liquid funds have actually delivered negative returns. Ultra Short Duration Funds have given -0.48%, market funds have given -0.51% and low duration funds have delivered -0.91%.

A quick look at the performance of liquid funds will tell you that these funds offer around 7-9% returns on an average. Hence, they are better than the 4% returns earned on savings account deposits. Like all other mutual fund schemes, liquid funds also charge an annual fee for offering fund management services.

In liquid funds, you can put your money today and take it out a day after, and you will get one day's return on your investment. So, there is no restriction, and they are very safe.

Liquid funds invest in highly rated short-term debt securities such as T-Bills and commercial papers. Arbitrage funds invest across debt, equity, and equity derivatives to leverage cash and futures market arbitrage opportunities while maintaining fully hedged positions.

Further, liquid funds must hold at least 20% of their assets in liquid products (cash and cash equivalents such as money market securities). This ensures that they can quickly meet any redemption demands.

Tax on Gains: Gains from liquid funds are subject to taxation. Short-term capital gains (STCG) within three years are added to your income and taxed at the applicable slab rate. Long-term capital gains (LTCG) after three years incur a flat 20% tax rate after indexation.

Interest rates offered on liquid funds is higher than those on Savings Accounts. You can access funds in your Savings Account any time you wish, whereas liquid funds are less accessible. You can get tax benefits on the interest income from Liquid Funds.

How much liquid funds should I have? ›

That should include a little cash stashed in the house, enough to cover the monthly bills in a checking account, and enough to cover an emergency in a savings account. For the emergency stash, most financial experts set an ambitious goal at the equivalent of six months of income.

Taxation on Liquid Funds

The taxation of liquid funds is based on the duration for which they are held: Short-term Capital Gains (STCG): If the units of a liquid fund are sold or redeemed within 3 years, any gains are classified as short-term capital gains and are taxed according to the investor's income tax slab rate.

Cash and Cash Equivalents

Cash is the most liquid asset possible as it is already in the form of money. This includes physical cash, savings account balances, and checking account balances.

These securities are at the bottom of the risk spectrum and therefore offer lower returns. Since liquid funds now must invest at least 20% of their assets in these low-return securities, part of the drop in returns can be attributed to the same.

Returns: Since liquid funds invest in short-term debt with maturities of up to 91 days, investors should look at one-month or three-month returns to measure fund performance. Returns over a longer horizon (one/three years) are not meant for a liquid fund.

What is meant by a liquid fund? A liquid fund is a form of mutual fund that invests in securities with a residual maturity of up to a period of 91 days. Moreover, these funds do not have a lock-in period since the underlying assets are not for the long term.

Shorter-term cash needs of 0-6 months should generally be kept in liquid accounts, such as savings, checking, money market accounts or Treasury notes. Cash needs between six months and three years can be supported using vehicles such as a 12-month CD or Treasury notes and bonds.