When there’s idle cash at hand, most of us instinctively dump it into our savings account and forget about it. It sits in the bank account idle, earning barely any returns. But we go with it because finding a place to park surplus funds without compromising liquidity can be challenging. This is where liquid funds come in.
Liquid mutual funds are a special category of debt funds that invest in, short maturity instruments, giving your idle cash a way to earn potentially better returns while remaining easy to access. In this article, we look at how liquid debt funds may help you manage idle cash more efficiently than simply leaving it in a savings account.
Table of Content
What Are Liquid Funds?
Liquid funds are debt mutual funds that invest in ultra short term debt and money market instruments with a maximum maturity window of 91 days. These instruments may include treasury bills, commercial papers, certificates of deposit and other government securities as specified by the RBI from time to time.
Now that you know the meaning of liquid funds, let’s look at their key features:
Investment in highly researched debt instruments may mean lower default and credit risk for liquid funds.
Since they invest in instruments that mature within 91 days, the NAV may be relatively stable over the short-term.
Liquid fund returns depends on the short-term interest rate prevalent in the market.
You can quickly access your investments because liquid fund redemptions are credited to your account within the next working day (if order is placed on a working day before 3 PM).
Minimum investment requirement may start as low as from Rs. 500 when investing via SIPs.
No exit load is applicable if the investment is withdrawn after 7 days. A graded exit load structure is used for an investment period of less than 7 days.
While credit and interest rate risks may be relatively low, liquid funds still carry market linked risks and are not completely risk free.
Liquid Funds vs Savings Account
The following comparison of liquid funds vs savings account may help you better understand how the two differ in terms of parking short-term funds:
| Parameter | Liquid Funds | Savings Account |
| Nature of Returns |
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| Potential Returns |
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| Liquidity |
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| Risk |
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| Tax |
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| Minimum Investment |
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| Suitable Purpose |
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What Makes Liquid Funds a Smarter Choice: Advantages of Liquid Fund Investments
From the liquid funds vs. savings account comparison table, it’s clear that liquid funds offer some significant advantages, especially if you do want your surplus money to work for you. Here’s why liquid fund investments may be a smarter choice than savings account if you have extra cash:
Better Potential Returns
Liquid fund returns are based on the performance of short term debt instruments. While they are not assured and may vary with market conditions, they may still offer better potential returns than savings accounts. That’s because:
Savings account interest rates typically range from 3%-4%, while liquid funds have historically shown an average return of about 7% .
Over time, even a slightly higher return can add up, giving your idle funds a better opportunity to grow.
Relatively Lower Risk and Volatility
Liquid fund investments may be a smart choice for low-risk investors because:
Liquid mutual funds invest in debt securities that mature within 91 days. While there is no guarantee, the short-term nature of these securities may mitigate interest rate swings to a significant extent.
These funds invest in well researched corporate and government instruments that may mean potentially lower default risk.
Easily Accessible
If you have idle cash today but may need it for emergencies or to meet future cash flow needs, liquid funds are suitable options. That’s because:
Liquid funds follow a T+1 settlement cycle, where if you place the redemption order before 3 PM on a working day, the amount is credited to your account within the next working day.
Some liquid mutual funds also offer an instant redemption facility allowing you to withdraw up to 50,000 or 90% of your investment within 30 minutes.
Flexible Investment Term and No Lock-In Period
Liquid funds are one of the most flexible short-term investment options. Here’s why:
They let you hold money for as long or as little as you like, offering flexibility for short-term or emergency use.
Liquid funds are open-ended mutual fund schemes that have no lock-in period.
You can withdraw your investment after the 7th day from the date of purchase without an exit load.
Taxation Benefit
The income you earn from your savings account is taxed differently from the earnings from liquid debt fund investments. Here’s how the two differ and how liquid funds emerge as smarter alternatives:
Interest income from savings accounts is added to your annual income and taxed as per your income slab.
If your interest income from savings accounts exceeds Rs. 10,000 (Rs. 50,000 in case of senior citizens) in a financial year, it will be subject to taxation as ‘Income from Other Sources’. So, if you have a large cash reserve and fall into the 30% tax bracket, you may end-up paying a large amount as tax.
Returns from liquid funds are taxed as capital gains only upon redemption. In other words, you pay taxes only when you redeem your liquid fund investment.
Who can consider Liquid Mutual Funds?
Now that you know the meaning of liquid funds and how they offer an edge over savings accounts, it’s easy to understand how they may fit certain portfolios. Liquid funds may be suitable for:
Individuals who have idle cash and prefer earning potentially better interest than savings accounts.
Those looking to create an emergency or contingency fund with easy liquidity.
Investors who want a temporary parking option while they evaluate long-term investment choices.
Factors to Consider When Investing in Liquid Funds
If you are considering liquid fund investments, you should review a few key things:
Expense Ratio: Liquid fund returns can be influenced by the expense ratio. Costs matter because the fund aims for stable outcomes from short term instruments.
Credit Quality: Look at the credit rating of underlying instruments. Portfolios with higher rated securities usually carry lower credit risk.
Fund House Approach: Understanding your fund house philosophy and its approach to risk management can help you make informed decisions.
Historical Performance: Past returns show how the fund reacted in different market situations, but they do not guarantee future performance.
Time Horizon: Liquid funds work well when your horizon is short term. Understanding your purpose helps you choose appropriately.
Taxation: You should note that liquid funds are currently taxed as debt funds, where the capital gains earned are added to your annual income and taxed as per your income tax slab. But remember, taxes will apply only when you redeem your units.
Conclusion
Keeping idle cash in your savings account might feel simplest, but it may not always be the most structured way to handle short term surplus money. Liquid funds offer a way to keep your money accessible while giving it the potential to earn a little more than a regular savings rate.
But before you choose liquid funds, do remember that they carry some credit risk, interest rate risk and market risk. So your returns are not guaranteed. As always, you should read all scheme related documents and understand the risk factors before investing.
Disclaimer
An Investor Education and Awareness Initiative by Tata Mutual Fund.
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