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All about liquid funds

July 14, 2009 12:40 IST
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While searching for different investment options, you might have come across the term 'Liquid Funds'. There are many of us who might have wondered what these funds are and more so after the news articles popped up telling everyone that investing in these funds is not a smart choice.

However, before we make a decision, let's discuss what Liquid Funds are.

What are Liquid Funds?

When we try and understand the term 'liquid' in financial terms, it means an asset which is as good as hard cash. Real estate is the least 'liquid' of all assets and a savings deposit is the most 'liquid' of all. Similarly, Liquid Funds are a kind of mutual fund or debt fund which can be redeemed in as less as 24 hours.

What are Liquid Funds invested in?

Liquid funds invest in money market instruments. Money market is a market for short term borrowing and lending. This market deals with debt instruments such as certificate of deposits, commercial paper and treasury bills.

What is the 'lock in' period for Liquid Funds?

Most funds have a lock-in period of a maximum of three days to protect against procedural (primarily banking) glitches, and offer redemption proceeds within 24 hours. However, some funds may even have a lock in period of a week or a month or more. However, the tenure is always far less than a normal mutual fund.

What are its features?

Here are some of the features of Liquid funds:

No Entry and Exit load (sometimes exit load is charged if redeemed before the lock in period)

Low annual fee 0.30 to 0.70%

Variable Minimum investment amount according to scheme

Great tax benefit

Easy liquidation, hence the name

An average 8% p.a return on liquid funds

Liquid funds have the restriction that they can only have 10 per cent or less mark-to-market component, indicating a lower interest rate risk.

What are the tax benefits?

If you invest in a short-term fixed deposit, the returns are taxable as per the investor's tax bracket. Therefore, if you are in the highest tax bracket most of your returns from the fixed deposit would be wiped out.

On the other hand with liquid funds, as mentioned before, if the dividend option is taken, the returns are tax-free in the investor's hand!

Has the past performance been good?

In the last one year, liquid funds have returned between 7.7 per cent and 8.85 per cent. Recent data shows that banks are taking fresh exposures in liquid funds which indicates a high degree of safety and confidence in liquid funds.

This shows that liquid funds are a good product to invest in if you are looking to fulfill some short-term goals.

How does it compare to a short-term fixed deposit?

Fixed Deposit

Liquid Funds

Returns on investments range between 4-5%

Returns on investments range between 5-8%

The interest on Fixed deposit is taxed by adding it to the assessee's income.

If you opt for a dividend option the dividend is tax free in the hands of the investor

Long Tenure

Very short tenure

Returns are fixed

Returns are not fixed

Not dependent on market performance

Dependant on market performance

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