Have extra money? Consider investing in liquid funds

When we talk about investments or savings, we usually envision money being set aside for several years to build a corpus. However, you can also strategically park surplus funds for a few months and benefit from potential returns. Liquid funds are one such avenue for short-term investments. A liquid fund is a type of debt mutual fund where the money you invest is put into fixed-income securities that have a maturity period of up to 91 days. You can dip into the money you invest in a liquid fund at any time, an exit load or fee is charged only if you withdraw within the first seven days of investing in this fund.
This article tells you more about liquid fund investments and their advantages and disadvantages.

• Table of contents:

1. What are liquid funds?
2. When should you put extra cash in liquid funds?
3. How do liquid funds compare to fixed deposits and savings accounts?
4. Disadvantages of investing in liquid funds

What are liquid funds?

Mutual funds are broadly of two types, based on asset class – equity and debt. While equity funds invest in stocks and shares, debt funds invest in fixed-income instruments such as corporate and government bonds and securities.
Liquid funds are debt funds that invest in very short-term instruments, such as treasury bills, certificates of deposits, commercial papers etc that have a maturity period of up to 91 days. The fund earns money in the form of interest and principal repayment on those underlying securities.

When should you put extra cash in liquid funds?

Let’s assume you receive a large sum of money – such as a bonus or a gift. You don’t need the money right now, but you have some expenses lined up in a few months and so you don’t want to lock away the surplus. Instead of leaving the money in your bank account till you need it, you can consider investing it in a liquid instrument where it has the potential to earn relatively reasonable returns.
The time-tested fixed deposit is one such way to set this money aside for a few months and earn interest on it. Another option is to invest in liquid funds. Such funds have the potential to earn similar or better returns than a fixed deposit over the same tenure. However, unlike fixed deposits, the returns form liquid funds aren’t guaranteed and are subject to market risks.
Moreover, they are highly liquid, so you can initiate a redemption whenever you need the money, and it reaches you within a day or two. Some fund houses also offer instant redemption of up to a certain amount, wherein money (up to Rs. 50,000 or 90% of the invested amount) is credited to your bank account within 30 minutes.

How do liquid funds compare to fixed deposits and savings accounts?

Liquid fund investments have an exit load period of seven days, after which redemption is without exit load. In comparison, most fixed deposits charge a penalty for premature withdrawal.
When you invest in liquid funds, you can also make partial redemptions, top up your savings, or stay invested for as long as you need to. In comparison, a fixed deposit has a fixed tenure, and you would need to start a new FD each time you want to put in more money.
In comparison to a savings account, liquid fund investments have the potential to yield relatively better growth but at a higher risk than savings account. Liquid funds are also beneficial for mutual fund investors who have opted for a Systematic Transfer Plan, wherein money is routinely transferred from one scheme to another – such as from debt to equity – to help withstand market fluctuations. You can also invest in liquid funds to park funds before switching to an equity fund or another instrument with relatively better growth potential.

Disadvantages of investing in liquid funds

While liquid funds are considered low-risk investments, there are no guaranteed returns, unlike in a savings account or a fixed deposit.
There are a few sources of risk for debt funds. Debt securities are inversely proportional to interest rate changes. When interest rates rise, based on the Reserve Bank of India’s policies, debt funds perform better, and vice versa. Debt funds also run the chance of credit risk, which is the risk of default by the company of which securities have been purchased.
Owing to the short maturity rating of the underlying assets, liquid funds are not as sensitive to these risks as other debt funds that invest over longer durations but are not immune to them either. The potential for returns on liquid funds is also low as compared to equity and some other mutual fund categories.

Conclusion

Liquid funds can be a good way to park surplus cash with the potential for reasonable returns. You can also look at the average returns of liquid funds given the market scenario at the time of investment and compare it with the returns on fixed deposits or other savings avenues. However, you must note that past performance may or may not be sustained in the future. When possible, consult a financial advisor for investment-related decisions. Lastly, you can consider investing in Bajaj Finserv Liquid Fund offered by Bajaj Finserv AMC for parking your surplus funds.

FAQs:

What are liquid funds?

Liquid funds are mutual funds that invest in short-term, highly liquid assets like government securities and certificates of deposit. They can be a suitable option for parking surplus funds temporarily.

Why should I consider investing in liquid funds?

Liquid funds usually offer relatively better growth potential than traditional savings accounts and are easily accessible, making them suitable for short-term investments with higher potential yields. However, unlike traditional savings accounts, the returns for liquid funds aren’t fixed.

What risks are associated with liquid funds?

While liquid funds are relatively low-risk/low to moderate risk, they aren't entirely risk-free. They can be impacted by interest rate fluctuations and credit risk of the underlying securities. It's essential to research before investing.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.