Liquid funds are a great tool for short-term investments and are often used as emergency funds. Liquid funds are often used as funds for school fees installments, holidays, insurance payments, medical expenses, etc. Additionally, most corporate use liquid funds for parking their short-term funds.
What are liquid funds?
Liquid funds are essentially funds that invest in short-term debt and money market bonds. They are not similar to equity or equity-related stocks. Liquid funds are invested in Treasury Bills, Term Deposits, Call Money Option, Commercial Papers and Certificate of Deposits (CDs). These funds usually have tenure of 1- 90 days.
The liquid fund offers returns that are low-risk.
The biggest advantage of liquid funds is that it provides you the access to debt securities which otherwise would not be possible. Debt securities are usually got only against a huge investment as at times few such bonds are expensive and beyond the reach of most customers.
In general, the main function of liquid funds is to provide high liquidity. The high liquidity is possible because the investors’ money is lent to credible borrowers with the assurance that the funds will be got back within a certain period of time and at the specified interest.
What are the risks of investing in Liquid funds?
As these funds invest in a variety of bonds where the borrower’s credibility is really high, chances of credit default risk are very rare.
A change in the interest rate will change the return in the bonds and subsequently the returns in the liquid funds as the interest rate and return in the fund move in an inverse ratio. It means, when the interest rate in the bond increases, the returns of the fund decreases and remains constant when the rate of interest is constant.
Also, as higher the tenure of the loan, lower would be the interest charged and subsequently, lower would be the return percentage. Thus, liquid funds are great for short term funds as they generally yield a better return than any other investment type that can be easily liquidated.
How is Liquid Fund a good STP Route?
Liquid funds are a great base for an STP(Systematic Transfer Plan) as you can park the fund in a liquid fund and deduct a certain amount and direct it towards the Equity Funds. This reduces the volatility risk of an equity market and its effect on a lump-sum investment.
Some of the liquid funds you can consider are;
1. L&T Liquid Fund – Direct (G)
2. Aditya Birla Sun Life Liquid Fund – Direct (G)
3. HDFC Liquid Fund – Direct (G)
Final Thoughts
It can be said that liquid fund is a fund where you can park a surplus amount for a specific amount of time and get a return more than you can get from similar traditional instruments with minimum risks compared to the equity market. Although you will have to bear an expense ratio, it is still a profitable instrument to consider.
Additionally, liquid funds offer the benefit of tax-free returns if the investment is continued for over three years. However, in such a case the returns would be hampered. Thus, it is advisable that you invest in a liquid fund for a short time and get more return than other types of traditional investment with similar features.