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Why Liquid Funds are a good option to park your idle funds

Dec 31, 2022 / Dwaipayan Bose | 23 Downloaded | 1909 Viewed | |
Why Liquid Funds are a good option to park your idle funds
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Many investors have substantial amounts lying idle in their savings bank accounts. Interest on savings bank balance is currently around 2.7 – 3%. Savings bank interest is taxable under the head “Income from other sources”. You can avail deduction of up to Rs 10,000 under Section 80TTA. Thereafter, the interest will be added to your income and taxed as per your income tax rate. Liquid funds canprovide much better yields on your idle funds and at the same time offer high liquidity also.

What are liquid funds?

Liquid funds are debt mutual fund schemeswhich invest primarily in money market instruments like treasury bills, certificate of deposits, commercial papers, treasury bills etc,that have a residual maturity of less than or equal to 91 days, with the objective of providing investors an opportunity to earn more returns on very short-term deposits, high degree of capital safety and liquidity.

Benefits of liquid funds

  • Superior short term yields: Rising yields, especially towards the shorter end of the yield curve has made 3 month yields quite attractive. Yields of 91 day Treasury Bills in RBI’s November auction was 6.44% (source: RBI). Yields of 1 month and 3 months Commercial Papers and Certificates of Deposit are 6.7 – 7.2% (source: CRISIL). You can get much better returns on the idle funds lying in your savings bank account by investing them in liquid funds.

  • Liquidity: Since liquid funds invest in papers which mature within 3 months they have high liquidity. Moreover as per SEBI’s circular on risk management framework for liquid and overnight funds (2019), liquid funds must hold 20% of their assets in liquid assets (i.e. assets which can be very quickly converted in cash). According to SEBI’s definition of liquid assets, they are cash, Treasury Bills, Government Securities and repos on Government Securities (e.g. TREPs, CBLOs). As such, these funds are highly liquid.

  • High degree of safety: Since liquid funds invest in very short maturity instruments, the price sensitivity of these instruments to interest rate changes is extremely low. In other words, liquid funds have low interest rate risk. SEBI has also initiated some regulatory measures to reduce the credit risk in liquid funds. As mentioned earlier, SEBI has mandated that 20% of the AUM of liquid funds will be held in risk-free instruments like Government Securities, Treasury Bills, TREPs, CBLOs and cash. Among other papers, SEBI has also capped exposure to single sectors at 20%. These measures will make liquid funds safer from a credit risk perspective.

  • Convenience: Liquid fund redemptions are processed within 24 hours on business days. Some asset management companies also offer instant redemption facility for liquid funds. For online instant redemption instructions, the redemption proceeds are usually credited to your savings bank account within 30 – 45 minutes of receiving the redemption request. Investors should note that, liquid funds charge exit load for redemptions within 7 days of investments. You should plan accordingly.

How to invest in Liquid Funds?

Investing in liquid funds is very simple. If you are KYC compliant, you can invest in liquid funds by filling an application form where you provide personal, investment and bank details. You can do this online or submit the application form at the offices of AMC or the Registrar and Transfer Agent (RTA). If you have an existing folio, then the online investment process is very simple; you simply need to provide the investment details and complete the transaction using net banking. Please note that the Net Asset Value (NAV) cut-off time for liquid funds is 1:30 PM. If your subscriptions (online / offline) is received by the AMC / RTA within the above time frame, then units will be allotted to you based on the current day’s NAV. For subscriptions received after 1:30 PM, next day’s NAV will be applicable. Consult with your mutual fund distributor if you need any help on this.

Suggested reading – Should you invest in debt funds when interest rates are rising?

Liquid fund redemptions

As per SEBI’s guidelines liquid fund redemptions must be processed by T+1. The NAV cut-off time for liquid fund redemptions is 3 PM. This means that you should place your redemption request before 3 PM, if you want to funds to be transferred to your bank account on the next day. As mentioned before, some AMCs provide instant redemption facility for liquid funds. Please consult with your mutual fund distributor or financial advisor to know about instant redemptions.

Systematic Transfer Plans

Systematic Transfer Plan (STP) is a mutual fund facility in which you can invest your lump funds in one mutual fund scheme (source scheme or transferor scheme) and then transfer systematically fixed amounts every month (or any other interval) to another mutual fund scheme (target scheme or transferee scheme). If you want to invest in an equity fund but are worried about market volatility, then you can invest in a liquid fund and transfer systematically to the equity fund using STP. By investing using STP you can take advantage of market volatility through Rupee Cost Averaging (RCA) and at the same time get yields on the funds in your liquid fund account.

Who should invest in liquid funds?

  • Investors who want to park their idle funds for a few weeks or a few months.

  • Investors who want high liquidity and high degree of capital safety.

  • Investors who want to invest in equity funds through STP from liquid funds.

  • Investors who can remain invested longer than 7 days, otherwise exit loads may apply.

Investors should consult their mutual fund distributors, if liquid funds are suitable for their short term investment needs.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

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