If you have a time horizon up to 1 year, you can invest in liquid funds. A liquid fund is a type of mutual fund which invests in debt securities with a maturity up to 91 days. This keeps the risk in these funds to a minimum. They give a return slightly more than fixed deposits of a similar maturity. However note that these returns are variable while fixed deposit returns are fixed. Liquid Funds are open ended funds, meaning that you can invest in them and redeem your investments in them on any business day. Several AMCs also provide ‘insta redemption facility’ in liquid funds, allowing you to get your money out in a matter of hours. A limit of Rs 2 lakh is usually set for this facility. Additionally some AMCs have linked their liquid funds to cards such as the Reliance Any Time Money Card, which can be linked to Reliance Liquid Fund. This allows you to directly spend the balance held in your liquid fund. These tie-ups also have limits, usually permitting spending up to Rs 1 lakh on the card and withdrawal up to Rs 50,000 per day.
Returns of Liquid Funds
The returns of liquid funds are close to those of fixed deposits of a similar maturity. Note that FD returns may be higher for higher tenure FDs like 3 or 5 yr FDs, however these are more comparable to short term debt funds than liquid funds.
|Time Period||1 year||3 years||5 years||10 years|
|Avg. Category Returns||6.88%||6.94%||7.62%||7.65%|
Source: Value Research. Data as on 27-12-2018
Current FD Rates in major banks
|Bank||1 year rate|
|Kotak Mahindra Bank||7.00%|
Source: Bank Websites Data as on 27-12.2018
The top performing liquid fund in 2018, Baroda Liquid Fund delivered 7.46%. This was followed by Franklin India Liquid Fund – Super Institutional Plan at 7.45% and Axis Liquid Fund at 7.44%. At the lower end, Principal Cash Management Fund returned -1.81%, Union Liquid Fund gave 3.61% and Reliance ETF Liquid BeES gave 5.43%. Several funds in the category were hit by the IL&FS crisis since they held debt issued by IL&FS, an infrastructure development company that ran into financial difficulties.
Rs 1 lakh invested in Baroda Liquid Fund would be Rs 107,460. Rs 1 lakh invested in Axis Liquid Fund 1 year ago, would now be worth Rs 107,440.
Tax on Liquid Funds
Your gains in liquid funds for a holding period of less than 3 years are characterised as Short Term Capital Gains and taxed at your slab rate. For example, assume that your slab rate is 30%. You invested Rs 10 lakh in a liquid fund and sold it after 1 year at an NAV of Rs 10.5 lakh. You have made a gain of Rs 50,000 in the liquid fund investment and the same will be taxed at 30%. A tax of Rs 15,000 will be payable (along with any applicable surcharge/cess). Liquid Funds held for more than 3 years will face Long Term Capital Gains Tax (LTCG) at 20%. You will also be given the benefit of indexation which accounts for inflation to reduce your tax burden. However it is not generally advisable to invest in liquid funds if you have a time horizon of more than 3 years. For such a time horizon, you can look at short term debt funds.
However note that no TDS is deducted on gains in liquid funds for resident Indians. On the other hand, TDS is deducted on FD if the interest received in a year is more than Rs 10,000. However for NRIs, TDS is deducted on both liquid funds and FDs.
Dividends on Liquid Funds are subject to Dividend Distribution Tax of 25%. Along with surcharge and cess, this tax becomes about 29%. It is deducted by the AMC at the time of declaring a dividend and hence the dividend itself is not taxable in the hands of the investor.
Risks in Liquid Funds:
- Credit Risk
Credit Risk is the risk of a borrower defaulting on debt securities held by a liquid fund. This recently happened with the IL&FS default with AMCs like Principal AMC hit hardest. Similar instances in the past included a default by Amtek Auto, affecting the funds of JP Morgan AMC and JSPL affecting the funds of Franklin Templeton and other AMCs. However in general such defaults are rare.
- Interest Rate Risk
The prices of debt securities fall when interest rates risk and vice versa.This is termed, interest rate risk. Liquid Funds face an extremely low level of interest rate risk because the maturity of their holdings is very low. In general, short maturity debt is least affected by interest rates and vice versa.
Top Liquid Funds
While choosing a liquid fund you should try to buy a fund with a strong track record and a relatively large size (AUM or Assets under Management). Large Liquid Funds tend to be associated with stronger research and management teams. They also have stronger bargaining power in the debt market. They also tend to be relatively less affected by sudden inflows and outflows from liquid funds by a few corporates or individual investors.
|Fund||1 year return||3 year return||AUM|
|Aditya Birla Sun Life Liquid Fund||7.41%||7.26%||Rs 62,310 crore|
|Axis Liquid Fund||7.44%||7.26%||Rs 23,723 crore|
|Reliance Liquid Fund||7.43%||7.26%||Rs 42,811 crore|
|Invesco Liquid Fund||7.41%||7.25%||Rs 10,634 crore|
|L&T Liquid Fund||7.41%||7.25%||Rs 15,862 crore|
Source: Value Research. Data as on 27-12-2018