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Investing can be a daunting task, especially with different choices available. Liquid funds have become popular as they are low on risk and high on liquidity. It is good for short-term goals and emergency funds, offering an alternative to traditional savings accounts. But how do you choose the right liquid fund? In this guide, we will discuss the liquid fund’s basics; highlight their advantages, and give tips on choosing the right liquid fund to meet your financial objectives.
What is a Liquid Fund?
Liquid fund is a type of mutual fund that invests in short-term debt instruments like treasury bills, commercial papers, and certificates of deposits. These funds aim at providing investors with a high level of liquidity making them suitable for those who want to park their surplus cash for shorter durations.
Key Characteristics of Liquid Funds
- Short Maturity Period
Liquid funds invest in funds that mature in not more than 91 days. This helps cut interest rate risk and maintain fund liquidity.
- Low Volatility
By nature, liquid funds are associated with less price volatility, arising from the short-term nature of their underlying funds. As a result, they end up being stable investment options.
- Quick Redemption
Investors can withdraw their investments in liquid funds within a reasonably short time, usually within 24 hours. The convenience of quick access to money has contributed significantly to their popularity.
Benefits of Investing in Liquid Funds
- Easy Access to Funds
Liquidity is one of the major advantages of investing in liquid funds: investors can easily get hold of their cash within a reasonable space of time, most frequently twenty-four hours after appealing for redemption.
- High Interest Rates
When compared to savings accounts, liquid funds offer higher returns on investment. Whereas savings accounts pay interest at specific rates, diversified investments by liquid funds into market instruments such as treasury bills, commercial papers as well as certificates of deposit may enable them to yield better returns.
- Minimal Risk of Different Interest Rates
Rates of interest risk are controlled by the fact that liquid funds are invested in short-term instruments with maturities of up to 91 days.
- No Lock-Up Periods
The distinguishing feature of this investment option is that there are no lock-in periods. This means that, without bothering about exit loads or penalties, you can put your money in and get it out whenever you like, thus providing unparalleled flexibility for managing your investments.
How to Choose the Right Liquid Fund?
Choosing the right liquid fund involves several considerations. The following are some key factors:
- Fund Performance
Go over past performance records of the liquid fund. It does not mean however that past performance determines future returns, but it helps to know how the fund worked its way through turbulent market times as well as its track record on returns.
- Expense Ratio
This represents what the fund charges its investors on an annual basis. When the expense ratio is low, more return goes to investors comparing similar funds.
- Credit Quality
Evaluate the creditworthiness of the underlying funds in the portfolio of the money market fund. Lower risk is implied by higher credit quality funds such as AAA-rated ones. The stability of the fund can be significantly affected by its creditworthiness.
- Asset Size of the Fund
The size of assets in a liquid fund can determine its performance. Large funds enjoy better diversification, which leads to more stable returns. However, very big funds may also confront difficulties in the effective deployment of huge amounts of money.
- Fund Manager’s Track Record
Expertise and track record are significant factors that influence how a mutual fund performs. An experienced fund manager who has successfully managed similar funds before would be one signpost.
- Investment Goals
Make sure you have chosen a liquid fund that fits your investment goals. The chosen fund should match your primary objective- liquidity and capital protection.
Comparing Liquid Funds with Other Debt Funds
While liquid funds are a part of debt funds, we need to understand their differences compared to other types of debt funds which will enable us to make an informed selection.
- Ultra Short-Term Funds
Instead of money market instruments, ultra-short-term funding invests in debt funds with a slightly extended time frame. The investments have a maturity range of 3-6 months and offer increased yields though incur higher risks.
- Short-Term Funds
Short-term funds invest in bonds that mature in between one and three years. This implies that such mutual funds can give higher returns than liquid ones but at the same time expose investors to enhanced interest rate risk.
- Income Funds
Income funds generally mix short-term with long-term fixed-income funds. These vehicles endeavor to provide regular income to their investors but they are also more sensitive to changes in interest rates.
Conclusion
Liquid funds are a rich resource in the hands of people who want to keep cash that can be changed into money, but without risk and with better gains compared to standard savings accounts. By understanding what is liquid fund and its role in your investment portfolio, you can effectively manage your short-term financial needs.
When selecting an appropriate liquid fund, you should consider some factors such as tax on Liquid Fund that perfectly fit into your financial goals as well as risk appetites. Investors who wish to put away extra monies for slightly more can or even stably invest should think about liquid funds because they give the kind of flexibility and liquidity that is required for efficient management of finances.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
