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What are liquid funds? and How do liquid funds work?

Liquid fund is an open-ended debt mutual fund scheme, ideal for short-term investments.

It invests primarily in money market instruments like Certificate of deposits, T-Bills, Commercial papers and Term deposits.

Maturity of the fund is 3-6 months.

Investors can enter/exit the scheme whenever desired.

Its is a low-risk instrument giving returns more than that received from bank.

How do liquid funds work?

Unlike other debt funds where NAV is calculated only for business days, NAV for liquid funds is calculated for 365 days.

NAV of liquid fund doesn’t fluctuate much as other funds.

Units are allotted as per previous day’s NAV if application is received before 2 p.m.

Withdrawal requests are processed in 24 hrs.

What are the benefits of investing in liquid fund?

No lock-in period: Withdrawals from liquid funds are processed within 24 hours on business days.

No entry and exit load: Unlike FDs, there is no penalty for exiting or breaking them

Lowest interest rate risk: Lowest interest rate risk because of high liquidity

Taxation: Dividends received are tax-free. However, taxation is applicable

Diversification: Investing a certain portion of your excess cash in liquid funds

How to choose a liquid fund?

Historic Returns: Past Performance of the fund and the track record of the AMC has to be checked.

Credit Rating: Highest rating is AAA. Higher credit rating denotes less chances of default, hence less risky.

Portfolio Allocation: Scheme’s portfolio and instruments in which allocation has been done has to be checked.

Average Maturity: Liquid funds invest in instruments which mature within 91 days. Lower average maturity indicates that the fund is holding more cash, which in turn gives less return.on capital gains.

Fund Objective: There are different plans like growth plans, daily dividend plan, weekly dividend plans and monthly dividend plans. Plans have to be chosen based on your risk appetite & fund requirement. helps you to meet emergency expenses and shield yourself from volatility of equity investments.

Can you explain a scenario where liquid fund could be used?

Consider a scenario:

You have to pay Rs. 1,00,000/- for your son’s college fee in the month of June and pay Rs. 60,000/- for your home loan EMI in July. So, the total amount payable is Rs. 1,60,000/- and you have Rs. 1,50,000/- lying idle in your salary account since April and you would like to invest it for a short-term.

You start pondering over various investment avenues and make a note of it:

Instrument Time Period Risk Return
Stock Markets Long term Very High Risk High Returns
Equity Funds Long term High Risk High Returns
Liquid Funds Short term Low Risk Stable Returns
Fixed Deposits Short term Lowest Risk Lowest Returns

You choose Liquid Funds because it is an ideal instrument for short-term with no lock-in period and at the same time generating moderate returns.