Reasons why people invest in liquid funds
Some people invest in a liquid fund to build and maintain an emergency fund. Some people invest in a liquid fund to park a lump sum amount for a short period until they figure out how to invest it. What is your reason for investing in a liquid fund? This article will guide you in selecting liquid funds to gain maximum return on your investment.
How to select a liquid fund?
While selecting a liquid fund for investment, you should consider the following parameters:
- Choosing the fund house
Before you get down to choosing the right liquid fund for yourself, it is important to choose the right fund house. You should make sure that you choose a fund house of reputation. The fund house should have the required expertise in managing different types of mutual fund schemes. The returns given by various mutual fund schemes of the fund house should be consistent. The fund managers of various schemes should have the required qualification and work experience of running various mutual fund schemes.
- Compare liquid fund schemes of various fund houses
You should compare the liquid funds of various fund houses before zeroing on a liquid fund scheme for investment. You should compare schemes on various parameters such as the current portfolio of the scheme, returns given by the scheme, assets under management (AUM), expense ratio, etc.
Most liquid funds invest in similar securities, and as a result, the returns will be more or less identical with some variation here and there. If there is a huge variation in the returns, you may check if the fund is taking higher risks to earn higher returns and whether you are okay with it.
- Fund portfolio
You should check the current portfolio of the scheme. Check the proportion of Treasury Bills and Government bonds. These fixed-income securities carry the lowest risk. Check the credit rating of other fixed-income securities in the scheme portfolio. Ideally, it should be the highest rating.
- Comparison of returns with bank deposits
Some investors consider liquid funds an alternative investment option to bank deposits such as savings accounts and fixed deposits. In that case, you may compare the returns of liquid funds with savings account interest and fixed deposit interest rates. In most cases, liquid funds will give better returns compared to savings account interest rates paid by most banks in the range of 2-4% p.a.
The fixed deposit rates may be better than liquid funds. But, you should compare the post-tax returns. For people in the highest tax bracket who wish to invest for more than three years, liquid funds are more tax-friendly than bank fixed deposits.
- Expense ratio
The expense ratio is charged to the scheme as a percentage of the assets under management (AUM). So, the expense ratio directly affects your returns as an investor. The lower the expense ratio, the better. Ideally, you should choose a liquid fund with a lower expense ratio for investment.
- Credit rating of the instruments
You should check the credit rating of the instruments in which the scheme has invested. Any fixed income securities, apart from Government securities, carry credit risk. There is a risk of default on principal repayment, interest repayment, or both. Is your investment objective capital protection rather than generating returns on it? In that case, you should give preference to a liquid fund that invests only in Government securities and other securities with the highest credit rating.
- Instant liquidity feature
As an investor, if you are looking to build and maintain an emergency fund, your preference should be for a liquid fund that offers the instant liquidity feature. Some liquid funds offer the insta redemption feature, through which the redemption proceeds are credited to the investor’s bank account instantly.
However, there may be limits on the amounts that can be redeemed through this feature. Some liquid funds allow redemption of 90% of the fund value or Rs. 50,000, whichever is lower through the insta redemption feature. For redemption of the remaining amount, an investor has to go through the regular redemption process.
Performance of liquid funds
Let us look at the performance of top liquid funds.
|AUM (Rs. crores)
|Quant Liquid Fund
|Franklin India Liquid Fund
|Mahindra Manulife Liquid Fund
|IDBI Liquid Fund
|Edelweiss Liquid Fund
Note: The returns are as of 20th Jan 2022. The returns are for direct plans with growth option. The one-year returns are absolute. The three and five-year returns are CAGR. The funds have been ranked based on five-year performance.