What are liquid funds?
# Debt funds that work in the money markets
# Short term parking place for cash
# Low risk MFs
# 3-month returns of 5-7 per cent pa
So summing up, why do liquid funds make sense?
# If you are in the highest tax bracket, they are just more tax efficient and that stacks up as higher post tax returns. Most liquid funds charge no entry or exit load; perhaps one or so might charge a exit load on exiting in less than six months but that's rare and between. The annual management fee is also very reasonable- upto 0.70 per cent.
Most importantly, they are very easy to liquidate and you can get your money back in one day of sending a redemption request and most liquid funds have a minimum investment amount of 5000 rupees; so they are fairly accessible to all investors.
A few points to remember:
Why liquid funds?
# Tax advantage
# Zero entry and exit
# Low annual fee of 0.30 to 0.70 per cent
# Redemption time 1 day
# Minimum investment Rs 5000
These funds have a specific purpose in your portfolio. They can be used to park short term cash. Suppose you are saving up to make an insurance premium payment in 6 months and you need a vehicle that will take you till there with a systematic plan. You can use these funds to target a sure-thing payment that is less than a year. It can be used to target a down payment for a house that is due less than a year away.
So, one way is to use them as a vehicle to target a certain lump sum investment.
Now, suppose you have a lump sum and you want to target staggered investing. You can again use liquid funds to do that.
How to use liquid funds?
# Park short term money
# Bucket to hold money for staggered investment
# Use in Systematic Transfer Plans
Before we move on to examine whether they really make better investment sense than short term FDs, let’s look at how they differ from other categories of debt funds.
The most popular long term category of debt funds popularly known as Income or Bond funds have much longer tenure than liquid funds and therefore have potentially more downside as also higher returns. Those are funds we recommend you look at with at least 18 months plus investment horizon or even longer.
Income funds primarily invest in different, albeit longer-tenured instruments like corporate bonds and government securities.
Then, there is one more category of long tenure but very safe funds and that's the gilt funds; these invest primarily only in government securities.
Liquid Funds vs other Debt funds
# Income or Bond funds have longer tenor
# Invest in long term debt investment
# Gilt funds invest government securities
Do they make sense over FDs especially with such high interest rates on FDs and dividend tax on liquid funds going up?
Liquid fund vs FDs
# Pre-tax FD rates 3-6 months : 5.25 to 8.00 per cent
# Av post-tax return from FDs: 3.5 to 5.3 per cent
# Post-tax returns (%)
- IDFC Liquidity Manager: 3 months has returned 5.64 and for 6 months 5.48
- Kotak Liquid: 6.76 for 3 months and 6.30 in six months
- Principal Money Manager: 5.03 for three months and 5.38 in six months
- UTI Money Market: 7.06 for three months and 6.63 in six months
The next big question is are liquid funds safe? We have all read front page stories saying liquid funds under redemption pressure of Net asset Values of liquid funds take a hit. So, how safe are they really? We asked ICICIdirect just that and here’s the answer.
ICICIdirect TIPS:
Liquid funds, like all other mutual funds faced temporary redemption pressures recently which caused some fund's NAV to fall. However, this was only a temporary phenomenon and is not an indicator of actual risk profiles.
# An investor should research the fund's portfolio and ideally invest in a fund that holds high quality papers and instruments
# Recent data shows that banks are taking fresh exposures in liquid funds which indicates a high degree of safety and confidence in liquid funds
So was this perhaps a short term phenomenon and there is no reason to be unduly concerned?
Rs 60,000 crore went out in less than a month and the market did not crack. That talks a lot about the resilience of the market and the product.
# Nothing wrong with the product
# Lack of liquidity hit funds
# Problem of depth and breadth of secondary market
# Problem is also with smaller liquid funds and/ or those funds that have a great and significant institutional-investor concentration
# Sebi working with RBI to sort issue
So there you go- 3-6 months liquid funds are a great parking place for your money, especially if bank FD rates come down from the current 7-8 per cent- liquid funds are a much better option for you.