Most of us have a similar habit of keeping money in a savings account to meet some short-term goal. We don’t look for other options to earn a better return with this money in the meantime. Ideally, bank balance equivalent to cover your 3 months expenses is sufficient and any surplus money should be taken out and invested in better yielding financial instruments. Liquid funds are one of such instruments in which the money kept for short-term goal can be invested to earn better returns.
Let’s shed some light on various aspects of liquid funds and what are the best short-term liquid funds to invest in 2015.
What is Liquid Fund in Mutual Fund?
Liquid Funds are open ended debt mutual fund schemes which primarily invest in money market instruments with maturities of up to 91 days. The liquid fund portfolio mainly includes cash assets such as treasury bills, certificates of deposit, commercial papers and term deposits.
Features and Benefits of Investing in Liquid Funds
- Liquid Funds have no lock-in period. You can withdraw your funds within 24 hours on business days. Usually, the cut-off time on withdrawal is 2 p.m. i.e. any withdrawal order placed before 2 p.m. will be executed on the same day and the amount gets credited in the bank account on the next business day by 10 a.m.
- Liquid Funds carries the lowest risk amongst all debt mutual funds. Due to the lower maturity period of underlying assets, the NAV of the funds doesn’t fluctuate much. In simple words, liquid funds invest in the fixed income securities with maturities of up to 91 days which are hardly traded, making the fund less volatile.
- Dividend Distribution Tax (DDT) applicable on Liquid Funds Returns is 28.325% (including surcharge and cess) which is to be paid by the AMCs.
- Similar to other mutual funds, Liquid Funds also offers two types of plans i.e. growth plan and dividend plan. Dividend plan offers dividend payout of various intervals namely daily, weekly and monthly.
- Further, investing in Liquid Funds attracts no exit load. This means there would not be any charges while redeeming Mutual Fund units.
Liquid Funds Return
Past Few years have not been very good for Liquid Funds investors as these funds manage to give returns at par with fixed deposits.
Best Performing Liquid Funds to invest in 2015
Top 9 liquid funds have been selected based on the various parameters explained below:
How to Choose a Liquid Fund?
Mutual fund selection requires some homework and there are various parameters which need to be considered while choosing best short-term liquid funds.
The Liquid Funds I have selected above are based on the following factors:
The first and the foremost factor to look at is Past Performance of the Liquid Funds. Funds which have given the highest return in the last 3 years have been shortlisted.
2. CRISIL Ranking
CRISIL Ranking is the second point to consider. High CRISIL Ranking denotes the strong fundamentals. Thus, funds having CRISIL Rankings of 1 or 2 are included in the list.
3. Asset under Management (AUM)
Higher AUM indicates the trust and confidence of the investors. Only Funds holding underlying assets worth at least a thousand crores are included in the list above.
Though I have considered the above points but you can further consider few other points as mentioned below:
4. Expense Ratio
Expense Ratio is the cost incurred by AMCs in managing funds which is passed on to the investors. Thus, funds having least expense ratios should be selected.
5. Track Record of Fund House
Last but not least is the track record of the fund house. You can compare other funds of the same house to get the knowledge how well the fund house is doing in Mutual Fund Investment.
6. Mutual Fund Manager
Mutual Fund Manager plays a vital role in investing, altering or removing any stock from the portfolio. So you can also consider the past performance of MF manager.
Tax Treatment of Liquid Funds
Tax Implications on liquid funds depends on the holding period.
- In case of holding period of liquid funds is more than 3 years, it is treated as long-term capital gain and tax is payable at flat rate of 20% with indexation benefit (inflated cost of purchase).
- If liquid fund is held for a period less than 3 years, than the gain is short-term capital gain and is taxed as per your tax slab.
How to Save Tax on Liquid Funds?
You can mitigate the impact of tax on liquid funds by adopting the following plans:
- If you fall in the highest tax bracket of 30% then you should opt for dividend payout as DDT is 28.325% which is less than the applicable tax rate of 30.9% (including education and higher education cess).
- For investors falling in the tax slab of 10% or 20%, dividend reinvestment is best suited plan because the capital gain on sell will be short-term and is taxed at the tax rate applicable to you which is way less than the DDT of 28.325%.
Liquid Funds vs. Savings Bank Account
- Return: Savings account gives the worst return of 4 to 6% per annum while the best performing liquid fund gave the return of 9.51% over one year.
- Tax: Interest Income from savings account if exceeds Rs.10,000 in a financial year becomes taxable in the hands of account holder while there is no such threshold limit in case of liquid funds. Dividends paid out by the funds are taxed at 28.325% (including surcharge and cess) which is deposited by AMCs.
Liquid Funds vs. Ultra-Short Term Debt Funds
- Investment: Liquid Funds invest in securities with maturities up to 90 days while Ultra-Short Term Debt Funds invests in securities with maturities exceeding 91 days.
- Risk: Since liquid funds invest in securities with lower maturity period, it is immune from market volatility thus less risky than ultra-short term debt funds.
- Exit Load: There is no exit load in Liquid Funds while ultra-short term debt funds levy Exit Load.
Liquid Funds vs. Fixed Deposits
- Returns: Fixed Deposit returns are always guaranteed while return from Liquid Funds tends to fluctuate with the market which, in case of rise in interest rates, is beneficial for investors.
- Safety: Bank Fixed Deposits are backed by RBI up to Rs.1 lakhs but there is no such backing for liquid funds.
- Penalty: Premature withdrawal from Fixed Deposit attracts penalty of 1% while there is no such penalty in liquid funds. You can withdraw amount whenever you need from liquid funds.
Tip on Investing in Liquid Funds
Best time to opt for Liquid Funds is inflation as RBI keeps interest rate high which in turn gives good return. At the time of falling interest rates, investors should better be staying away as the returns from liquid funds may fall with falling interest rates.
Apart from market events, one should also go for liquid funds when there is sudden inflow of cash either because of bonus or any legal settlement etc. Investing money in liquid funds is far better option than parking it in savings account.
Another way to utilize liquid funds is to invest lump sum receipts in liquid funds and start systematic transfer plan to invest in chosen equity funds. This notion is similar to SIP through bank account but investing money in liquid funds and then transferring it to liquid funds will yield slightly better returns.