Liquid funds

Liquid funds are good option prefer to park the money in the bank. Liquid funds gives investor the same benefit, plus a little more yield than what investor will earn in a savings account.

Enter liquid funds also known as cash funds. They have more potential than a savings bank account or fixed deposit for that matter. They offer returns slightly higher than fixed deposits apart from offering the same level of security. In short, liquid funds can be used as substitute to investor’s savings bank account.

Cash funds invest primarily in money market instruments, such as commercial paper, certificate of deposits, treasury bills, and call money market for a shorter duration. They are extremely low-risk and very liquid, meaning that investor can change it into cash assets at any time. Their aim is to secure returns that are better than bank savings account and more liquid than term deposits. Hence when the uncertainty over investor’s expense ends i.e. Investor know when and how much investor need to do is redeem the units which will give investor the desired funds, Liquid funds are mandated by SEBI to process the redemption proceeds within 24 hours. Investors are advised to do provide for three to four days to receive clear funds in their bank accounts.

Liquid funds differ from debt funds i.e. the income funds and gilt funds. The gilt and income funds have a higher maturity profile and provide superior returns over a long term but are susceptible to interest rate risk. Since income and gilt funds invest in long term and medium term instruments, they are more prone to changes in interest rates. Liquidity in these funds comes at a cost known as exit load. Liquid funds provide returns less than debt funds and have a shorter maturity profile. But they score over income and gilt funds in terms of liquidity, as they are no load funds. Liquid funds are the least risky instruments.

Cash funds are known to provide steady returns with minimal risk and focus on capital preservation. These funds also cash in the interest rate volatility, as short-term funds are less prone to changes in interest rates. Hence such funds are most sought after by the conservative investor who does not want to trade his principal for a risky return.

With minimal returns of 4% p.a., savings bank account offers anytime and easy liquidity, and safety of capital. Fixed deposits of a short-term tenure of 6 months offer 6.00-6.50% p.a. returns. In contrast, cash funds have generated superior returns. Cash funds, on the other hand, provide safety of capital as well as 24 hour liquidity and no loads. Their daily and weekly dividend options make them all the more attractive. The dividends are reinvested back at the ex-dividend NAV. The minimum investment amount in these funds ranges from Rs 5,000 to Rs 1,00,000.

Many mutual funds have tied up with banks allowing direct credit to investors' account implying that the investor need not go to the mutual fund's office for collecting redemption cheques. This means that an investor can submit his redemption request on Monday morning before 10 or 10:30 IST and get a redemption request processed based on the closing NAV of Sunday and get a redemption cheque on the next working day. Almost all liquid funds declare NAVs on Sundays and on public holidays. All this can be done at NAV based prices since liquid funds do not charge any entry or exit loads. Secondly their anywhere cash facility allows an investor to redeem his units from any mutual fund's centre other than the place he invested from.

In terms of taxation, the Budget 2002 has put mutual funds at par with bank deposits. Liquid funds will be chargeable to tax at individual taxation rates. Any income above Rs 1,000 would be subject to tax deduction at source at the rate of 10%. Deduction is also allowed in respect of this income under section 80 L within the overall ceiling of Rs 9,000. Still the short-term losses can be offset with short-term gains from mutual funds. In case of bank deposits, interest income received is eligible for deduction under Section 80L up to Rs 9,000.

Retired people or people nearing retirement should invest in liquid funds. Because at this stage, the last thing you want to do is invest your money in risky propositions. Even if you are an aggressive investor, you should have some portion of your investment portfolios in money market instruments or liquid instruments for stability and liquidity. In case you need some emergency cash, you can redeem your liquid fund with almost no loss to capital. But one should remember that investments in liquid account do not in any way insure against loss.