Liquid Funds: Making your idle money work

Savings bank is the default choice for most individuals and families for parking their savings for short periods. Savings bank provides high liquidity and convenience to account holders. You can draw money from your savings bank account either through ATM or branch and pay bills through cheques or online banking. However, the yield on savings bank balance is very low; most banks pay 3.5 to 4% interest on balances in savings bank account. On a post tax basis, the interest earned on savings bank deposit is much lower than the inflation rate. Money market mutual fund schemes like liquid funds and ultra short duration funds offer high liquidity and high degree of safety, yet provide much better yields compared to savings account for money that you may not need for a few days, few weeks or few months. Liquid mutual funds are ideal investment choices for parking funds for a few days to few months (3 months or so), enjoy high liquidity and get decent returns.

What are liquid mutual funds?

Liquid funds invest primarily in money market instruments like treasury bills, certificate of deposits, commercial papers, treasury bills etc,that have a residual maturity of less than or equal to 91 days, with the objective of providing investors an opportunity to earn more returns on very short term deposits, high degree of capital safety and liquidity. Withdrawals from liquid funds are processed within 24 hours on business days.

Benefits of liquid mutual funds

• Superior short term yields:

  Liquid funds can give 2 – 4% higher returns than savings bank account interest rates. They are ideal solutions for accruing stable income from your idle funds. Liquid funds usually generate higher returns than savings bank interest. If you have on an average a balance of Rs 1 Lakh in your savings bank account, by investing it in liquid funds, you can get Rs 2,000 to Rs 4,000 higher income in a year, which over long period of time (15 – 20 years) can result in substantial financial benefits due to compounding.
  
  From time to time, you receive large one-time cash-flows like bonus and incentives, maturity proceeds of fixed maturity savings schemes and life insurance policies, property sales proceeds etc. These monies tend to lie idle (unproductive) in your savings bank accounts for long periods of time, till you find a use for it. By investing your idle monies in liquid funds, you can generate substantial income for yourself, without compromising on liquidity for end use of the funds.
  
  Suggested reading – why should you park your surplus savings in liquid funds
  
  Liquidity and convenience: Liquid funds also offer very high liquidity. As discussed earlier, redemptions are processed within 24 hours on business days and credited to your bank account. There is no exit load in liquid funds; you can draw your money at any time, partially or fully, without any penalty or charges.



• High degree of safety:

  Liquid funds are money market instruments – they do give assured returns. Liquid fund returns depend on prevailing money market rates. Since liquid funds invest in very short maturity instruments, the price sensitivity of these instruments to interest rate changes is extremely low. SEBI has also initiated some regulatory measures to reduce the credit risk in liquid funds. SEBI has recently mandated that 20% of the assets under management of liquid funds will be held in risk-free instruments like Government Securities, Treasury Bills and cash. SEBI has also capped exposure to single sectors at 20%. These measures will make liquid funds safer from a credit risk perspective.



• Tax efficiency:

  Unlike savings bank account, there is no Tax Deducted Source on returns accrued in the liquid funds. Profits or capital gains in liquid fund investments held for less than 3 years are taxed as per the income tax slab of the investor. Though liquid funds are meant for very short term investments, from a few days to a few months, there can be situations when you can hold your liquid fund investments for a long time. Capital gains in liquid fund investments held for more than 3 years are taxed at 20% after allowing for indexation benefits. Indexation benefits reduce the tax-payers obligations substantially.

How to invest in Liquid Funds

Investing in liquid mutual funds is very simple. If you are KYC compliant, you can invest in liquid funds by filling an application form where you provide personal, investment and bank details. You can do this online or through paper form with the help of an AMFI registered financial advisor. If you are not KYC compliant, then you can become compliant by submitting your KYC documents like identity proof and address proof to Registrars / Transfer Agencies or Asset Management Companies (AMC). Your financial advisor can help you in this process.

Conclusion

Liquid funds are ideal for parking funds for a period of few days, few weeks or few months and are ideal investment choices for money that investors may need to use at a very short notice or do not when they will need to use it. You should consult with your financial advisors to discuss if liquid funds are suitable for your investment needs.