Is it the right time to invest in liquid funds?

Are you an investor who keeps your surplus funds in savings accounts? Do you want an alternative investment option that addresses your liquidity and safety concerns?

Look no further, liquid funds are that investment option.

What are liquid funds?

Liquid funds are a category of mutual fund schemes that invest fund money in the money market or debt securities such as treasury bills, commercial papers, certificates of deposits, or corporate bonds.

As per SEBI norms, these funds must invest the money collected from investors in securities having residual maturity of less than 91 days. Liquid funds normally don’t invest in risky assets, thereby helping in minimising credit risk.

Since liquid funds are mandated to invest a minimum of 20 per cent in cash and cash equivalent up to 20 per cent of their assets, they can meet the redemption requests of investors easily.

Liquid funds earn income mainly through interest payments they receive from the issuers of debt securities and only a very negligible part of their income is generated through capital gains.

Why invest in a liquid fund?

Individuals keep idle funds in a savings account for many reasons.

For some, it could be to meet contingencies like hospitalisation expenses, loss of income due to loss of job et cetera. Others may have got a large amount of money on the sale of real estate or through inheritance.

Others could have parked funds to be deployed in gold, equity, or real estate when opportunities arise. Most of the banks pay saving bank account interest ranging from 3 percent to 4 percent. Investors want their money to be as safe and liquid as possible and are indifferent to returns while keeping funds in a savings account.

Like savings accounts, liquid funds also offer you safety and liquidity. They are safe as your money is invested in high-quality debt products and they offer liquidity since there is no lock-in period and redemption requests are processed within one working day. Some funds are even offering instant credit to your bank account.

There are also no exit loads in liquid funds. In addition, you can expect a higher return in a liquid fund compared with a savings account. You can also do an STP from a liquid fund to any other equity fund which works like a SIP while also earning returns in the corpus in the liquid fund.

How are gains taxed?

Short-term capital gains (STCG) will arise if you sell or redeem the units of a liquid fund within 36 months of purchase. The gains are added to your income and you are taxed as per the tax slab you are in.

On the other hand, if you redeem units after 36 months, you are said to have made Long-term capital gains (LTCG). LTCG tax is 20 percent with indexation. Indexation helps you to inflate the purchase price by using the Cost Inflation Index provided by the Central Board of Direct Taxes before calculating the capital gain. On this front, liquid funds score over savings bank accounts.

However, you can claim saving bank account interest of up to Rs10, 000 as a deduction from your income under Section 80TTA of the Income Tax Act. The other advantage of savings accounts in banks is that they are insured up to Rs 5 lakh by DICGC.

Liquid funds are one of the very popular investment avenues with corporates, HNIs and retail investors in India.

(The writer is a CFA and former banker who currently teaches at Manipal Academy of Higher Education, Bengaluru.)