Investing in Liquid Funds: A smarter Alternative to Savings Accounts

When we find ourselves with a sudden influx of money, whether it’s a bonus, proceeds from selling an asset, or funds set aside for planned expense, why let your money sit idle in a savings account? Instead, consider investing in liquid funds.

If you have surplus cash, leaving it in a bank savings account may not be your best bet. If you want to beat bank rates while keeping a check on the inflation and see the purchasing power of your extra cash grow, liquid funds are generally considered as a much more efficient option compared to traditional savings account.

What are Liquid Funds in a Mutual Fund context?

Liquid funds are high liquidity open-ended income schemes that invest in debt and money market instruments, such as government securities, treasury bills, and call money among others. These instruments have a maximum maturity period of 91 days, making them safer by mitigating interest rate volatility risk. Withdrawal request from these funds are typically processed within one working day.

One unique aspect of liquid funds compared to other funds in the debt category is the applicability of Net Asset Value (NAV). Regardless of the investment amount, units in liquid fund are allotted based on the previous day's NAV if the application is received before the cut-off time (usually up to 1.30 pm). Investors typically choose to invest in these funds for periods ranging from 7 days to 91 days.

The role of a fund manager managing such a fund is primarily focused on capital protection, and investments are made carefully, being mindful of returns and liquidity. Key factors of a good liquid fund include low expense ratio, good overall credit quality of the portfolio, and a disciplined approach to investing. Investments made in liquid funds are highly liquid.

Management fees of liquid funds are relatively low compared to other mutual funds schemes.

Most people keep their savings and excess funds parked in a savings account, considering it a safe choice with easy access to withdrawals. While the money in bank account is insured up to 5 lakhs by DICGC (a government body), the interest rates earned by a typical bank saving account range from 3.5% to 4.25% p.a. In contrast, investing in a liquid fund can provide an average yearly return of around 6.5%, subject to returns linked to the underlying securities in the portfolio minus expenses. While investors do take on some level of risk for higher returns, the possibility of default in the underlying securities is fairly low. Investing in liquid funds is generally considered to be prudent, especially when dealing with larger sums of capital exceeding 5 lakhs. Banks do not insure amounts exceeding 5 lakhs, making liquid funds a better option to achieve possibly higher returns.

Pros and cons of investing in liquid funds

Pros

• Liquid funds offer pre-tax returns which are linked to underlying securities in the portfolio, compared to the 3.5%- 4% p.a. returns provided by savings accounts.
• Most liquid funds also offer instant redemption access for withdrawals up to Rs. 50,000.
• No lock-in period.
• Withdrawals are processed within 24 hours.
• No exit load fee from the 7th day onwards. A minimal fee ranging from 0.0070% to 0.0045% is charged for redemptions made between the 1st and 6th day of investment.

​​​Cons

• Savings bank accounts provide insurance coverage of up to Rs. 5 lakhs under DICGC. This feature is not available with liquid funds.

Consider this example:

Let’s assume one has a total sum of Rs 80,000 lying idle in bank account and they have to pay Rs. 50,000 for daughter's school fee in June, and in July, they have an insurance premium of Rs. 30,000 to pay. Now instead of keeping the funds in account, one may consider investing them for a short time frame. While stock markets or equity funds may be too risky for these important payments, and bank fixed deposits would lock in money with low returns, liquid funds offer a better alternative.

Liquid funds are designed to allow redemption of units within 24 hours, providing quick access to your funds. By investing in a liquid fund, there are chances that you can earn a little more than what you would have earned in a bank fixed deposit while maintaining the same tax liability as an FD or savings account.

In conclusion, liquid funds are ideal for investing your spare cash for a shorter time frame and earning better returns compared to a savings account. Therefore, liquid funds can serve as an ideal alternative to short-term fixed deposits.

The information contained in this document is for general purposes only and not an investment advice. Readers should seek professional advice before taking any investment related decisions.

The information contained in this document is for general purposes only and not an investment advice. Readers should seek professional advice before taking any investment related decisions.

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