Best Liquid Funds 2022 - Top 10 Liquid Funds

How do liquid mutual funds work?

Liquid mutual funds have the investment objective of capital preservation and providing liquidity to their investors. Accordingly, the fund manager invests in high-quality debt securities and makes sure that the average maturity of the scheme’s portfolio is no longer than 91 days. This short maturity period ensures liquid fund returns are less prone to interest rate changes. 
The best liquid funds always match the maturity of their portfolio to that of their individual securities. 
Moreover, according to SEBI’s latest guidelines, liquid funds can only invest in listed commercial papers. In addition, these schemes can have a 25% overall exposure limit in each sector. 
Furthermore, liquid mutual funds must hold at least 20% of their assets in liquid products like money market securities, cash and cash equivalents, etc.

Who Should Invest in Liquid Funds?

The returns offered by liquid funds are much higher than that of a regular savings bank account. Therefore, if you have any surplus funds, then you may consider parking them in liquid funds and earn better returns. As the fund mostly invests in high-quality securities, the risk-averse investors may also consider investing in liquid funds.

Things to consider as an investor

Fund Objectives

Liquid funds are the least risky among all classes of debt funds. The NAV doesn’t fluctuate too frequently as the underlying assets have maturity period in the range of 60 days to 91 days. This prevents the NAV of liquid funds from getting impacted by the underlying asset price fluctuations. However, there might be a chance of a sudden drop in NAV. This can happen due to an abrupt decline in the credit rating of the underlying security. In simple words, liquid funds are not entirely risk-free, but safer than most other classes of mutual funds.

Expected Returns

Historically, liquid funds have provided returns in the range of 7% to 9%, which is way higher than the mere 3.5% interest that a regular savings bank account offers. Even though the returns on liquid funds are not guaranteed, more often than not, they have delivered positive returns on redemption.

Cost

Liquid funds, like all mutual funds, levy a fee to manage investments, called ‘expense ratio’. The Securities and Exchange Board of India (SEBI) has mandated the expense ratio to be under 2.25%. Considering the hold till maturity strategy of the fund manager, liquid funds maintain a lower expense ratio to offer comparatively higher returns over a short period.

Investment Horizon

Liquid funds are exclusively for investing the surplus cash over a short duration, say up to three months. Such a short horizon helps to realise the full potential of the underlying securities. In case you have a longer investment horizon of up to one year, then you may consider investing in ultra-short-term funds to get relatively higher returns.

Financial Goals

If you want to create an emergency fund, then liquid funds can prove to be very useful. Since there is no lock-in period, it helps you pull out your money quickly in case of emergencies.

Risk of Liquid Funds

As the assets that the liquid funds invest in mature within 91 days, these funds do not witness high volatility. This translates to the net asset value (NAV) of liquid funds remaining relatively stabler as compared to other classes of debt funds. Therefore, this kind of mutual funds is said to be suitable for risk-averse investors.

Nevertheless, like any other investment option, even the liquid funds are not entirely risk-free. If there is any change in the credit ratings of the underlying securities, then it may lead to a change in the NAV of the fund. Therefore, even liquid funds are not entirely risk-free. However, the short maturity period of the underlying securities mitigates the associated risks to a great extent.

Taxability of Liquid Funds

The dividends offered by liquid funds, if any, will be added to your overall income and taxed as per the income tax slab you fall under. The rules of taxation of debt funds apply to the capital gains provided by liquid funds.

You make short-term capital gains on redeeming your investment within three years from the date of allotment. These gains are added to your income and taxed as per the income tax slab you fall under. You make long-term capital gains on selling your debt fund units after three years. These gains are taxed at a rate of 20% after indexation.

Advantages of Best Mutual Funds

The following are the most significant advantages of investing in income funds:

1. Low cost

The liquid funds are not actively managed like most other debt funds. Therefore, the expense ratio of liquid funds is on the lower side, resulting in higher take-home returns.

1. Low risk

As mentioned earlier, the risk possessed by liquid funds is on the lower side as the underlying securities mature within 91 days. This mitigates the risk of volatility.

1. Flexibility

Liquid funds, as the name suggests, are open-ended mutual funds. Therefore, you can redeem your units at any time. However, a small charge in the form of an exit load is levied on exiting within seven days from the date of allotment.

1. Faster processing

The redemption requests are generally processed within a working day. Some liquid funds facilitate instant redemption.

FAQs

1. Do liquid funds have a lock-in period?

No, liquid funds do not have a lock-in period. Thus, you can redeem your money at any point in time.

2. Is there an exit load on liquid funds?

Yes, there is an exit load only if you withdraw within 7 days of investing in a liquid mutual fund. After this period, there are no exit load on the liquid funds.

3. Are liquid funds a risky investment?

Liquid funds only invest in short-term securities. Thus, any kind of changes in interest rates do not significantly affect its market value. Hence, liquid funds do not have much capital gains or losses.

4. Do liquid mutual funds offer guaranteed returns?

No, liquid mutual funds do not provide guaranteed returns. Although, due to their unique portfolios, they provide very stable returns.

5. Can investors opt for SIPs in liquid funds?

Yes, investors can opt for SIPs in liquid funds. They can select the frequency at which they want to invest, and the money will get auto-deducted from their bank accounts.

6. Are liquid mutual funds better than short-term FDs?

Yes, liquid mutual funds are a better investment option than short-term FDs as they have no lock-in period. Furthermore, there is no penalty if you withdraw your money after 7 days.