Financial planning can include multiple goals – some that are in the near future, some that are several years away. Each goal may require different investment avenues and approaches. For a short-term goal, low volatility is important so that the invested capital can stay relatively stable. That’s where liquid mutual funds can come in.
Such funds can be an attractive option for investors seeking a relatively stable avenue where they can potentially earn better returns than savings accounts. This article tells you more about what liquid funds are and what role they can play in an investment portfolio.
What are liquid funds?
Liquid funds are a type of debt mutual fund that invest primarily in short-term debt and money market securities like Treasury bills, commercial papers, and certificates of deposit with a maturity of up to 91 days. The high credit quality of the papers and the low duration of the portfolio makes the investments relatively stable.
The quality of these papers mitigates default risk – which is the risk that the issuer of the debt security may default on repayment. The low duration, meanwhile, reduces interest rate risk. The value of fixed income securities is inversely proportional to prevailing interest rates in the economy – which means they go down when interest rates go up, and vice versa. The longer the duration of the security, the greater the sensitivity to interest rates.
Also, as the name suggests, such funds offer high liquidity, meaning investors can convert their investments into cash quickly.
Why choose liquid funds?
- Low risk: Liquid funds invest in high-quality debt instruments with short maturities, which reduces the risk of default and interest rate fluctuations. This makes them a relatively stable option compared to other types of mutual funds like equity funds or long-duration debt securities.
- Better Returns potential than Savings Accounts: While not as high as equity, liquid funds offer better return potential than traditional savings accounts. This makes them a good option for conservative investors who want to earn a little more money on their idle cash.
- High liquidity: Liquidity refers to the ease with which an asset can be quickly converted into cash without a significant affect in its value. Liquid funds offer high liquidity, which means the asset can be sold swiftly with minimal risk of a change in prices.
How to use liquid funds
Liquid funds can be suitable for several investment purposes. These include:
- Emergency fund: Liquid funds can be useful for building and maintaining an emergency corpus. Life is unpredictable, and having a financial cushion can help you navigate unexpected expenses. By parking extra cash in a liquid fund, you can utilise a relatively stable and accessible avenue that also offers better return potential than a savings account.
- Short-term goals: If you have short-term financial goals, such as planning a vacation or buying a new gadget, liquid funds can be a suitable avenue. Since these funds offer higher return potential than savings accounts with low-to-moderate risk, they can help you grow your money while keeping it accessible for when you need it.
- Parking surplus cash: If you have surplus cash that you don’t plan to use immediately, parking it in a liquid fund can be a smart move. This allows your money to work for you, potentially earning better returns than it would in a savings account, without locking it away for long.
- For conservative investors: Investors who are wary of equity mutual funds but still want better return potential than traditional avenues can consider liquid funds.
- Systematic investment plan (SIP): Another effective way to utilise liquid funds is through an SIP. By setting up a SIP, you can regularly invest a fixed amount into a liquid fund, which can help you build a disciplined savings habit. Over time, the potential returns from the liquid fund can add up, giving you a modest corpus with small but regular investments.
- For a systematic transfer plan: You can also use liquid funds as a part of a Systematic Transfer Plan (STP). This involves transferring a fixed amount from one scheme to another scheme of the same mutual fund company at regular intervals. It is typically used to transfer funds from debt mutual funds to equity funds. Instead of investing in one go in equity, STP allows investors to manage market volatility effectively by staggering their investments and leaving a part of their funds in a relatively stable avenue.
Using an SIP calculator
If you’re planning to invest in liquid funds through a Systematic Investment Plan, using an SIP calculator can be helpful. An SIP calculator allows you to input details like the amount you want to invest, the duration of the investment and the expected rate of return. It then calculates the potential future value of your investment, helping you understand how much you can potentially earn. This can aid in planning your finances and setting realistic goals. Keep in mind, however, that the calculator’s estimates will be based on the expected rate of return, which may or may not be achieved.
With the right approach, liquid funds can be a valuable addition to your investment portfolio, providing relatively stability as well as better return potential than traditional savings accounts. This can make them suitable for conservative investors, building an emergency fund, park surplus cash or save up for a short-term goal. However, it’s important to do your research and understand your risk tolerance before investing. It is also recommended to consult a financial advisor before making major investment decisions.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.
