Liquid mutual funds are one of the variants of debt funds. They invest in fixed-income instruments like commercial paper, treasury bills, and government securities. These instruments have a maturity of up to 91 days. The fund manager calculates the NAV of your liquid fund investment for 365 days. Furthermore, the AMC will process your withdrawal within 24 hours. Low interest-rate risk is a reason behind the popularity of liquid funds.
How do liquid funds work?
This mutual fund investment aims to provide liquidity and capital protection to the investors. The fund manager selects high-quality debt securities and invests as per the scheme mandate to achieve the aim above. The manager also selects securities with an average maturity of approximately 91 days. Shorter maturity makes the liquid funds less prone to interest rate changes. The fund managers try to deliver higher returns by matching the maturity of individual securities with that of the portfolio. Investors prefer liquid funds because they offer better returns than a regular savings account.
You can opt for the SIP investment mode to invest in a liquid mutual fund. Use a free online SIP calculator to determine the monthly investment amount.
What risks are involved in liquid funds?
Like all mutual fund schemes, liquid funds also involve numerous investment risks. Here are a few potential risks involved in these investments:
Interest rate risk:
Interest rate risk signifies the possibility of bond price changes because of fluctuating interest rates. The decline in bond prices is because of the high-interest rates and vice versa. While the interest rate risk is negligible because liquid funds invest in low-maturity securities, you should still look for interest rate risks.
Credit risk:
Unlike traditional savings or fixed deposit accounts, liquid mutual funds returns are not assured. Even though these mutual funds invest in high-quality securities, risk is inevitable. There is no guarantee that you will get the invested capital when you consider redeeming your mutual fund units.
Inflation risk:
Liquid fund returns are lower than other volatile investments like stocks and bonds. That’s the case because of their safety and short-term maturity. Thus, there is a possibility that the returns may not match inflation.
Despite the risks above, you must consider investing in liquid mutual funds.
What are the advantages of liquid funds?
Here are a few benefits why you must consider investing in liquid mutual funds regardless of the risks involved:
1. Minimal risks:
A liquid fund is a low-risk debt fund because it allocates funds to government securities. As they invest in securities maturing in less than 91 days, the risks associated are low. On the contrary, securities with long maturity have credit fluctuation risks.
2. High liquidity:
Liquid funds are highly liquid, meaning you can redeem them without hassle as they have no lock-in period. Your withdrawals are processed within 24 hours of the request.
3. Expense ratio:
Liquid funds are managed professionally. Therefore, AMCs charge expense ratio, i.e., management fees. Investment returns and expense ratios are inversely proportional. Because of passive management, liquid funds carry a low expense ratio. Furthermore, liquid funds have an exit load of fewer than seven days. You can redeem your liquid fund investment within just seven days without paying any penalty charge.
Conclusion:
Liquid funds can generate a stable income for you, but it is comparatively lower than other securities. So, if your risk tolerance is low, consider investing in a liquid fund.
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