If you are looking for investment options, you will come across multiple financial products with varying degrees of risk associated with them. Moreover, different instruments also invest in different asset categories. One such popular category is debt or fixed income, which is usually preferred to reduce risk and volatility. To invest in this category, many investors take the route of debt mutual funds. Further, liquid funds appear prominently while looking for debt funds.

What are liquid funds?

Liquid funds are a type of debt funds that are considered a relatively safer type of investment assets than most other types of market-linked funds. Commercial papers, corporate bonds, treasury bills are some of the underlying portfolio asset types of liquid funds. Investors can get the option to opt out from this type of investment within as early as 24 hours.

How do liquid funds work?

The main objective of debt funds is capital protection and to provide stable and decent returns. The fund managers, therefore, select bonds that have good credit ratings (the better the credit rating, the safer the funds are). Liquid funds have a maturity of up to 91 days, and hence fund managers also ensure that they select bonds that have a low maturity period. Short-term debt funds are less likely to be affected due to market volatility. Liquid funds may also provide comparatively better returns than savings accounts and fixed deposits.

Advantages of liquid fund investment

Decent returns: Liquid funds pose low-risk and are usually stable. They may offer better returns than fixed deposits.

High liquidity: Liquid funds have high liquidity of T+1 day (market days). If you withdraw from liquid fund investment today, then your redeemed amount will be deposited in your bank account tomorrow or the next business day.

Low risk: Investors with a low-risk appetite can invest in liquid funds because it usually carries low risk than other investment tools in debt mutual funds.

No lock-in period: After seven days of your liquid fund investment, you can withdraw it without any type of exit loads.

Disadvantages of liquid fund investment

Lowest interest rate risk: Liquid funds are likely to have the lowest interest rate risk, which makes them less prone to market volatility, and they cannot take advantage of high returns that are offered by market dynamics.

Exit load: Although there is no lock-in period in liquid funds, the funds are liable for an exit load on withdrawal before 7 days of investment. A small percentage of exit load is levied, which is in accordance with SEBI guidelines.

Taxation

A liquid fund is a typically considered as a short-term investment option. However, the taxation for you as an investor depends upon your holding period. If you hold the liquid fund units for less than 3 years, the returns are considered to be short-term capital gains and taxed as per your income tax slab. If the holding period is over 3 years, the returns get indexation benefit and are then taxed as long term capital gains and taxed at 20%.

Who should invest in liquid funds?

-Short term investors

-Senior citizens

-Investors seeking capital protection

-Investors looking for bank deposit alternatives

How to invest in liquid funds?

Investment advisory platforms have made it easy to invest with just a few clicks. The account opening process is paperless and hassle-free.If you are looking for appropriate investment avenues to park your savings, or to earn good returns, it is prudent to reach out to a financial advisory service-provider that can help you to create an effective financial plan, including choosing the appropriate investment routes and financial products for you to reach your financial goals.