Seven things you need to know while investing in liquid funds
Since demonetisation, bank accounts have been in the constant limelight. Though normalcy has returned with the remonetisation nearly complete and RBI relaxing restrictions, the jolt has prodded many to look at alternative options to manage their money.For those looking for a safe avenue to park their money for short durations, investing in Liquid funds is ideal.
What are liquid funds?
Liquid fund is a type of mutual fund which invests in money market instruments like treasury bills, corporate papers and bank certificate of deposits. Most of these instruments have either none or low risk, have a fixed interest rate and fixed maturity. Liquid funds, therefore by definition is classified as an open-ended debt fund with funds investing in money market and debt instruments with a residual maturity of up to 91 days. According to AMFI the retail AUM of liquid funds increased from Rs.4,100 crore in March 2016 to Rs.5,800 crore in March 2017, a growth of 43% or an addition of Rs.1700 crore over a year.
Compared to traditional savings products, liquid funds offer reasonable returns. As liquid funds invest in market securities, an uptick in inflation would keep the interest rates high, which would tighten liquidity. This allows liquid funds to give reasonable returns.
Many investors take the first step towards investing usually via SIPs in an equity or debt fund. However during an emergency, they tend to break these investments first which erodes the potential of the investment and in some cases may prove to be a loss for the investor. Any financial planner will always recommend creating a contingency fund first, before taking the plunge into investing. Liquid funds can be one such option for those wishing to create such a fund over traditional methods. Allocate an amount say equal to 3-6 months expenses and deploy it into a liquid fund.
STP (Systematic transfer plans)
SIPs have become popular route for non-HNIs and the salaried class to invest in mutual funds. Through a SIP, a certain amount is transferred from your bank account to the scheme periodically. With the aid of compounding, SIPs may be prudent for those seeking to build wealth in the long term.However, many investors might want to reinvest their potential returns or might want to invest a lump sum amount. Here, a Systematic Transfer Plan (STP) into a liquid fund might provide an edge to the investor compared to other avenues. STP allows an investor to invest a predefined amount through regular transfers from one scheme into another scheme of the same mutual fund. Instead of letting the amount from a scheme sit idle, investors may transfer their money in a liquid fund or any other scheme; get reasonable returns before redeploying that amount into another scheme.
Since liquid funds by definition are short term debt funds, tax liabilities remain the same. For a growth option, the investor is taxed on the any capital gains (CG) according to his/her tax slab. CG is added to the income of the investor and then taxed. For those opting for a dividend option, dividends are tax-free at the hands of the investor. There is a dividend distribution tax (DDT) for retail investors at 28.84% including surcharge and cess which is deducted from it the NAV of the scheme and the NAV of the scheme, pursuant to pay out would fall to the extent of payout and statutory levy(if applicable).
Investing in a fund
While picking a fund will primarily depend on the investor’s goal, there are a few parameters which can narrow the search. Since, institutional investors mostly comprise 93% of liquid funds; you may pick a fund with a large AUM. In case a few players decide to pull out a few hundred crores, a large fund will be less volatile compared to the havoc wreaked on a smaller fund. Also fund managers might try to get reasonable returns by investing riskier commercial papers. For a risk averse investor, seek to pick a fund with a majority of its assets in treasury bills over corporate papers. Finally, pick a fund with a low expense ratio as a high expense ratio may significantly impact returns.
Liquidity in funds
Most liquid funds usually do not have an exit load and may be redeemed in a single working day. However, AMCs have used innovation to make the process even faster. For example, Aditya Birla Sun Life Mutual Fund has launched a mobile app -liquid fund based mobile app which allows customers to transfer money from their bank account directly to the Aditya Birla Sun Life Cash Plus (An Open ended Liquid Scheme) and also redeem i.e. withdraw back into their account.Here’s Why You Should Invest In Equity Mutual FundsIn the end, liquid funds are an avenue to invest that would otherwise stay idle in an account. They not only offer reasonable returns, but also seek convenience of liquidity over short term like any regular account.For Scheme details, refer SID and KIM on Aditya Birla Sun Life Cash PlusMutual Fund investments are subject to market risks, read all scheme related documents carefully.
Are mutual funds a reasonable investment in bull market?
Equity-oriented schemes account for around 32.8% of the industry's assets. (March 2017. Source: AMFI) Equity-oriented schemes derive 85% of their assets from individual investors. (March 2017. Source: AMFI)