What are Liquid Funds? 7 Best Liquid Funds to Invest in 2021

Mutual funds for students

What are Liquid Funds?

Liquid funds are mutual funds that invest their corpus in monetary instruments like Fixed Deposits, Treasury Bills, Bill Re-discounting, Cash Equivalent and different debt securities with maturity up to 90 days. These are the open-ended schemes that provide a short-term investment option and have the lowest interest risk associated with all class of debt funds.

The NAV (Net Asset Value) of the funds is calculated for one year, unlike other debt mutual funds where NAV is computed only for business days. They don’t have any restrictions of a lock-in period and enable withdrawals to be processed within twenty-four hours on business days. The investment objective is to preserve capital and supply financial gain. For this, the fund manager of liquid fund invests solely in investment grade debt instruments.

The best part is that there’s no exit load in the case of liquid funds. You can choose to invest for a few days or few months depending on your financial goals. These are out there in variants like daily/weekly/monthly dividend and growth possibility. You can also earn steady returns over a brief time interval.

What are the advantages of Liquid Funds?

1. High Liquidity: You can withdraw your money within 24 hours.
Expense ratio: Liquid Funds have a lower expense ratio than all mutual fund schemes.
3. Low Risk: Liquid fund investments are considered less volatile as they’re invested in instruments with high credit rating, and hence offer low risk.
4. Short Maturity Period: They invest in ninety-one days of maturity amount instruments.
5. Good Returns: They easily offer returns between 6-8%.
6. Consistent Behavior: Unlike other mutual funds, the Net Asset Value (NAV) of liquid funds does not vary too much against other mutual funds.
7. Safe Investment: They’re the best investment option for those investors who do not want to take any additional risk, do not even want to invest in the stock market and want good permanent returns on the money.

Who can invest in Liquid Funds?

Since these funds provide high returns, it is advised that investors looking to park their idle money should consider liquid funds as a viable option. Ideally, they should be utilized to achieve your short-term goals. Since some funds generate around 8% to 9% returns, they should surely be preferred over savings account and fixed deposits which provide 4% to 6% returns.

How to evaluate Liquid funds?

There are various factors that you should take into account when evaluating which Liquid Fund to invest in. Below are a few:

Fund Returns

Fund performance plays a vital role in the choice of funds. Although what returns you may get will be independent of its past performance, the returns still become an important metric to consider. Funds that have a robust history of consistent performance, within the investment domain, could also be trusted to remain resilient throughout slumps and market rally.

Choose funds that have outperformed their benchmark and peer funds in a consistent manner across say 3, 5 and 10 years. However, keep in mind to investigate the fund performance that matches your investment horizon to the desired results.

Expense Ratio

Expense ratio shows the operating efficiency of a mutual fund scheme. It basically means how good your funds are being managed. It shows how much of your invested amount is being used to manage the expenses of the fund. A lower expense ratio gives higher take-home returns for the investor. Hence, choose a fund with a lower expense ratio which can give you very good returns.

Financial Ratios

In addition to using plain vanilla returns, there is a range of financial ratios available which can be used to analyze the performance of the mutual fund from different prospects. You may apply tools like standard deviation, sharpe ratio, alpha and beta to examine the risk-adjusted returns and relative risk of a fund.

A fund having higher standard deviation and beta is riskier than a fund with lower beta and standard deviation. Find a fund with a higher Sharpe ratio as it will give you higher returns on every additional unit of risk taken.

7 Best Liquid Funds to invest in 2021

While choosing a fund, you would like to investigate the fund in a holistic manner. There are various quantitative and qualitative parameters which can be used to find the right funds as per your needs. Also, you would like to keep your money goals, risk appetite and investment horizon in mind.

Investors may choose the best Liquid funds to invest based on the investment horizon like 3 years or 5 years returns.

Fund Name 3 Year Return 5 Year Return
Nippon India Liquid Fund 17.25% 34.04%
Edelweiss Liquid Fund 17.01% 33.08%
Quant Liquid Fund 19.01% 36.00%
ICICI Prudential Liquid Fund 17.10% 33.82%
Axis Liquid Fund 17.23% 34.08%
Invesco India Liquid Fund 16.79% 33.51%
HDFC Liquid Fund 16.73% 33.08%

*The order of funds doesn’t counsel any recommendations. Investors may choose the funds as per their financial goals. Returns area unit subject to vary.

When should Liquid Funds investments be made?

If you want to make an investment for a short time period, it is better to invest your money in liquid funds as they invest in instruments up to a maturity of 91 days. You can invest your money for short periods ranging from 1 day to 3 months.

For example, if you see a sudden cash influx or get a high bonus, it is a good idea to invest in mutual funds. Thus, it’s good to park excess money in channels that facilitate higher returns at an equivalent time given by liquidity. Returns from them are generally greater than bank saving accounts and FDs.

Are Liquid Funds tax-free?

When it comes to liquid funds, the dividend income is tax-free in the hands of the investors. For the growth option, the taxes are dependent on whether you’re investing for long-term or short-term.

Short Term Capital Gain Tax

This applies to Liquid Funds of 36 months or less, i.e. less than 3 years. In short-term capital gain tax, tax calculation on funds is done according to the income tax/income tax slab of the person.

Long-term capital gain tax

This applies to 36 months or more, i.e. over 3 years of liquid funds. The tax here is calculated on the amount of profit, with a cost indexation of 20%. (Indexation is a way of reducing the effect of inflation on your purchasing value and giving you less tax on your capital gain.)

FD vs. Liquid Funds: Which gives Higher Returns?

InformationFixed DepositDebt funds
Amount invested₹ 1 million₹ 1 million
Return Rate (suppose)10%10%
Lock-in period5 years5 years
The value of the amount at the end of the period₹ 15,00,000₹ 15,00,000
Inflation every year8%8%
Indexed Investment Amount-₹ 14,00,000
Taxable amount₹ 5,00,000₹ 1,00,000
Paid tax₹ 1,50,000₹ 20,000
Post-tax return₹ 3,50,000₹ 480,000

Even if a bank gives a similar rate of FD and liquid fund returns, the latter over 3 years of investment will give a higher post-tax return.

You may consider liquid funds as inefficient tax vehicles as they suffer from short-term capital gains tax (at your regular tax slab) if held for less than a year. Hence, if you’re within the high bracket, this does hurt. But there’s a lot of economical strategies to handle this.

Consider opting for dividend reinvestment. The dividends stripped will be reinvested as units. These will be considered as fresh investments. With a low NAV stripped off dividend and reinvested units considered as a fresh cost, your capital gain (sale-cost) will be almost nil or very low.

Written by