What are Liquid Funds?
Liquid funds are debt funds that invest into short term fixed return instruments like Government Bonds, Treasury Bills, Certificate of Deposits, Commercial Papers etc. As the name suggests, the goal of these funds is to provide high liquidity while providing high returns when compared to other options like Fixed Deposits.
These are situational but smart investments for those with surplus money that would otherwise sit in a Savings Account for the same period of time. Some important distinguishing features of such funds are-
Features of Liquid Funds:
There is virtually no Lock-in period for these investments. The maturity period can be anywhere between 1 day and 3 months, due to which this option is a favorite of investors looking mainly for liquidity.
SEBI has capped the maximum Expense Ratio of these funds at 2.25%, but the number is normally lower in order to maximize returns. Also, these have no entry or exit loads, which brings the cost even lower.
These have almost zero default risk as the securities are normally guaranteed by the government. However, these are still subject to interest rate fluctuations, and therefore dependent on the markets. So, theoretically, there is a possibility of loss but that is not seen in most cases.
Who should invest?
Liquid funds are ideal for people looking to park their money for a small period of time (up to 3 months). Generally speaking, Liquid funds give returns of 7-9% which are much higher than any other option available in this risk grade, while maintaining liquidity.
It is not advisable to put all of one's corpus, including emergency funds, into liquid funds at once, as it takes at least 1 day to process the request.
Investors tend to use these when a new inflow of cash is acquired (through promotion/bonus or sale of an asset, etc.), at the expectation of a fixed expense, like children's school fees, or to further invest in equity funds using a Systematic Transfer Plan (STP).