Liquid Funds FAQ
What are Liquid Funds and how are they different from other debt funds?
Liquid Funds invest into debt securities with very short maturities. The residual maturities if bonds held by liquid funds do not exceed 60 to 90 days. Many liquid funds prefer to maintain average maturities that are even lower (15-20 days). As per rules prescribed by SEBI, bonds maturing within two months need not be ‘marked to market’ – only their interest component needs to be factored in while calculating NAV’s (net asset values). Hence, the NAVs of Liquid Funds remain relatively steady compared to other debt funds.
Are Liquid Funds Risk Free?
Liquid funds are very low risk, but not risk free. Despite the fund management team’s best efforts, sometimes bonds held by liquid funds default (as was the case with Taurus Mutual Fund recently). Owing to their very short maturities, this remains a remote possibility - but the risk still exists on paper. When a bond held by a liquid fund defaults, the fund needs to write off its value. This results in a hit on the fund’s NAV. In a nutshell – liquid funds are very low risk, but not risk free. It’s best to stick with liquid funds of large and renowned AMC’s, which employ more robust research teams.
Do Liquid Funds provide guaranteed returns?
Unlike Fixed Deposits or Savings Accounts, Liquid Funds do not provide guaranteed returns. However, they do provide very steady returns, owing to the nature of their portfolios. In the present scenario, liquid funds can be expected to provide annualized returns in the range of 6% to 7%.
How are Liquid Funds used in STP’s (Systematic Transfer Plans)?
Their low volatility, steady returns and zero exit costs make liquid funds an ideal choice as a pass-through vehicle for STP’s (Systematic Transfer Plans) into equity funds. Say, you have 5 lakhs sitting in your savings account (earning 3.5% per annum) and you’d like to invest this money into equities, for the long term. However, you are sceptical about rich valuations and the short-term direction of the stock markets. In such a scenario, you could choose to park the 5 lakhs into a liquid fund, and initiate an STP into an equity fund from it. Over time, your liquid fund balance would be transferred to your chosen equity fund. In this way, you’ll be protected from the risk of investing your entire money at an interim market peak. You’ll benefit from corrections as you’ll be making a staggered entry into the equity fund. At the same time, your idle balance will earn better returns than your savings bank account.
How are Liquid Fund returns taxed?
Profits earned on your liquid fund units (at the time of redeeming or switching them) are taxed per your income tax bracket if done within three years (a likely scenario, as liquid funds are meant for short term investments). In the unlikely scenario that you hold on to your liquid fund units for more than 3 years, the profits will be indexed for inflation and taxed at a flat rate of 20%.
How soon can I get my money back from my Liquid Fund?
If you log in the redemption request before 3 pm today, you’ll get your money in your account the next morning. However, SEBI has recently mandated that AMC’s should allow instant redemptions of up to Rs. 50,000 from Liquid Funds. Many AMC’s have already implemented this. Your Financial Advisor can help you clarify which funds currently offer this facility, and which ones do not.
