Understanding Liquid Funds: Key Benefits, Strategies, and Insights

Liquid funds are a great investment option for those who wish to enjoy a stable flow of income with a low to moderate level of risk. They are a type of debt fund that offers you many different categories to choose from as per your investment preference and risk profile. 

In this article, we will walk you through the benefits, risks, and returns you can expect by investing in liquid mutual funds. Let’s begin by discussing liquid funds’ meaning in some more detail. 

So, What are Liquid Funds?

Liquid funds are a type of debt fund that invests in fixed-income securities with a maturity period of up to 91 days. These include treasury bills, certificates of deposit, government securities, and commercial papers.

Since the maturity period of liquid funds is low, they come with a very low-interest rate risk. The credit risk of these funds is determined based on their credit rating. 

As per SEBI regulations, fund houses need to classify debt funds under one of the three credit risk classes – Class A, Class B, and Class C. 

If the fund falls under Class A, it features a low credit risk; if it falls under Class C, it features a high credit risk. Liquid funds fall under category A.

While selecting a liquid fund, you must keep the following pointers in mind:

Historical returns

 It is important to check how the liquid fund has performed in the past to get an idea of how much you can expect in returns. To get an idea of a fund’s performance you can check returns generated by the fund during the last 3 to 5 years to get a correct idea about its performance.

Credit rating

Another key factor to consider is the liquid funds’ rating. Please ensure it matches your risk appetite

Portfolio allocation

You must also check the funds allocated to different securities by the fund house to understand if it matches your investment preferences.

Fund Objective

You must examine if the fund’s objective aligns with your investment objective. Also, check if the fund is focused on capital appreciation or providing dividends.

How Can Liquid Funds Help You?

Liquid funds are a great investment instrument to park your money. They provide you with a steady flow of income and a great amount of liquidity—meaning greater autonomy over your withdrawals. Due to this benefit, you can also use them as an emergency fund while enjoying a return on them. For instance, this liquidity is not available with a fixed deposit which often comes with a lock-in period that disallows withdrawals.

Moreover, liquid funds help you hedge inflationary and market forces acting on your portfolio by providing the required debt exposure to it. And all these benefits become available to you via liquid funds at minimal interest rate risk.

How Do Liquid Funds Work?

Since liquid funds are a type of mutual fund, they collect money from different investors and put it in debt instruments that mature in a period of up to 91 days. 

Professionals experienced in asset management are responsible for managing these funds. Thus, when you invest your money in a liquid fund, depending on the type of your funds, you do not need to monitor it constantly for buying or redeeming securities; a fund manager does it for you.

There are two types of plans under any mutual fund – a regular plan and a direct plan. In case they are direct plans, then the investor invests directly in the scheme without any agent. However, such investors are often market experts or veterans who know the ins and outs of the same. For the rest, there is the regular plan wherein you invest with the help of an agent or intermediary.

Let’s understand this better with the help of an example:

Mr. A wants to invest Rs 50,000 in a liquid fund to grow his money. Mr A puts for the XYZ Liquid Fund (Direct Plan-Growth), which invests around 81.8% of his money gets invested in debt instruments featuring a maximum maturity period of 91 days. The balance of 18.2% is invested in cash and cash equivalents. Now, Mr A need not monitor or invest in these securities. The fund manager will do this on his behalf.

The Importance (Benefits) of Investing in Liquid Funds

Now, let us look at some key benefits of investing in liquid funds: 

1. Stable returns – Since liquid funds invest in fixed-income securities, you can earn a steady flow of income by investing in this category of debt mutual funds.
2. Low-interest rate risk – Liquid funds feature a very low-interest rate risk as they invest in securities that mature in 91 days. So, there are fewer chances of interest rate fluctuations. 
3. High liquidity – Unlike traditional fixed-income generating investment avenues like fixed deposits, liquid funds come with no locking period. Thus, they qualify as a highly liquid investment option.
4. Taxation benefit – If you redeem your liquid fund units after three years, you can enjoy the benefit of indexation. This benefit increases your purchase price, which in turn lowers your profit amount and hence your tax liability.
5. High flexibility – Liquid funds come with two options – a growth option and a dividend option. You can choose the former option if you wish to go for capital appreciation and the dividend option if you want to enjoy the stability of returns.
6. Low expense ratio – Unlike other debt funds, liquid funds need not be very actively managed by the fund manager, given the short maturity period of the securities. Thus, liquid funds are available at highly affordable expense ratios.

How to Use Jupiter Money’s return on Investment Calculator?

You can use our Return on Investment Calculator by following the below-mentioned steps:

1. Visit our official website – Jupiter Money
2. Go to the ‘Reso’Resources’ion and click on the ‘Calculators’ from the drop-down list.
3. Select the “Return on Investment” calculator from the list of all calculators.
4. Enter your investment amount.
5. Enter your expected investment amount.
6. Select your investment period
7. After completing the above steps, a pie chart will be displayed on the right side of the screen, mentioning all the key details like your investment gain, your return on investment, absolute return, and CAGR.

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Written and Reviewed by:

Priyanka Rao

Author

Priyanka Rao is a content strategist for Jupiter.Money, and specializes in writing on topics related to finance, banking, budgeting, salary & wages, and other financial matters. She has a passion for creating engaging content that resonates with audiences across various digital platforms. In her free time, Priyanka enjoys traveling and reading, which allows her to gain new perspectives and inspiration for her work. With a keen eye for detail and a creative mindset, Priyanka is committed to creating content that connects well with her readers, enhancing their digital experiences.