Liquid funds – product features:

For those who have large surplus funds in their saving account for short term, a liquid fund can be a great substitute for the saving account. A liquid fund can provide the same kind of liquidity and convenience of withdrawal like a saving account but will offer a much higher return than saving account.

For example, you have sold your shares and have a short-term surplus of say Rs. 10 lakh in your saving account, which you would like to use to buy shares again in a month’s time whenever share prices go down. Keeping the surplus fund of Rs. 10 lakh in your saving account will earn you 4% interest per annum. If you park the same Rs 10 lakh in a liquid fund, you can earn a higher return of about 7% per annum.

You can also withdraw the funds fully or partly whenever you need any number of times, as you do in a saving account, without any exit load.

Liquid funds – how they work?

Liquid funds aims at providing a high degree of liquidity and safety of the capital to the investor. For this reason, the fund manager invests in high-credit quality, short- maturity debt instruments or money market instruments.

The fund manager ensures that the average maturity of the portfolio is maximum up to three months. This reduces the sensitivity of fund value to interest rate changes. The fund value does not experience severe fluctuations, as interest rates do not fluctuate much in the short-maturity duration of underlying debt investments.

Things to consider while investing in liquid funds:

A) Risk:

For liquid funds, the NAV doesn’t fluctuate too frequently as the underlying assets mature within 60 days to 90 days and the interest rate risk is low. However, the fund value might drop due to a sudden downgrade of the credit rating of the underlying security. In simple words, liquid funds are exposed to credit risks of underlying securities.

B) Returns:

Historically, liquid funds have generated returns in the range of 7% to 9%. It is way higher than the 4% returns obtained on a savings bank account.

C) Charges:

Liquid funds charge a fee to manage your investment called expense ratio. SEBI has mandated the upper limit of expense ratio to be 1.05%. However, liquid funds maintain a much lower expense ratio, to provide relatively higher returns over a short period.

D) Investment horizon:

Liquid funds are exclusively meant to invest surplus cash over a short period say, up to three months. Liquid Funds help to realize the full return potential of short-term surplus funds. In case you have a longer investment horizon of up to one year, then you may consider investing in ultra-short-term funds.

E) Financial goals:

If you want to create an emergency fund, then liquid funds can prove to be very useful. In addition to receiving higher returns, these will help you to take out your money quickly in case of emergencies.

F) Top 5 liquid funds:

The following table gives the top 5 liquid funds in India based on the past year returns.