Why Investment in Liquid Fund is a Wise Decision for Investors?

We all have at least one bank account but we should not put all our money in our bank accounts because there is another financial instrument which works similar to a bank account but the ROI is much more than a bank account and is almost as safe as a bank account. I am talking about the liquid fund and here’s why it should find a place in everybody’s portfolio.

Savings bank account fetches you around 4% to 6 % interest per annum but it would be a wise decision to keep your money in liquid funds because data associated with funds says that the best liquid funds have returned as high as 7.5-8% on an average in the past, daily, on an annualized basis. So, liquid funds score much higher over a savings bank account on the ROI front.

Also Read: Why Liquid Funds are Better than Saving Accounts?

Liquid Fund dividends are currently subjected to a dividend distribution tax of 28.84% while your bank interest gets taxed at income tax rates. So, if you are an investor who comes in the 30% tax bracket, a dividend plan would be more efficient. It even doesn’t matter if you are in the 10% and 20% tax brackets, you will earn more from a liquid fund, post-taxes, when compared to a savings bank account. Historically, liquid funds have returned much more money than a savings bank account because liquid funds can generate income for you from additional markets while your bank account cannot do so. For example, a liquid fund can generate additional money from the fixed income market but the savings bank accounts would not be able to do so. Additionally, Liquid funds also help you to transfer balances from your savings bank account so that you can avoid being an impulsive spendthrift.

Read Related Blog: Best Liquid Funds to Invest in 2018?

Financial planners recommend that investors must build a contingency fund. A contingencies fund or contingency fund is a fund for emergencies or unexpected outflows, mainly economic crises. Investors, who wish to start SIPs in Mutual funds, do not show any faith in liquid funds and hence they do not find liquid funds lucrative enough to build an emergency corpus. However, the opinion of distributors and financial advisers is different and they recommend some money to be invested in a liquid fund, along with equity funds.

One of the best and disciplined ways to invest in Mutual funds is through a systematic investment plan (SIP). Paisabazaar defines SIP as follows - “It is a method of investing in mutual funds which allow investors to invest a fixed sum in a mutual fund scheme at fixed intervals. Under the SIP mode of investing, a fixed amount is deducted from the investor’s savings account on a daily/monthly/quarterly/semi-annually basis and is directed towards the chosen mutual fund scheme.” There is another method to invest in Mutual Funds which is called as STP or Systematic Transfer Plan.

According to Money Control, Investors can use Systematic Transfer Plan (STP) as a defense mechanism in a volatile market. This plan is used to transfer investment from one asset or asset type into another asset or asset type. Systematic transfer plans (STPs) earn a bit more than a traditional SIP because the idle money that lies in your liquid fund earns a slightly higher return in the range of 7-8% before it gets deployed in an equity fund. So, investors can use liquid funds as a parking place. They can keep the money in a liquid fund, where the money will appreciate and this will also give time to the investor to decide what he wants to do with it. He can either deploy it in equity MFs or withdraw. It should be noted that in cases of STPs, both the liquid funds and the equity funds should belong to the same fund house because transferring money from a liquid fund into equity fund where both funds belong to different fund houses is not allowed.

Capital markets regulator, Securities and Exchange Board of India (SEBI) frames down rules associated with Mutual Funds. All investments that mature by 60 days are to be accounted for, on an accrual basis while those while that mature after 60 days must be valued on a mark-to-market basis. The net asset value (NAV) of liquid funds keeps going up at a steady rate on a daily basis. This is the reason why the liquid fund gets back its entire principal at the end of the tenure. Securities that trade beyond 60 days like ultra short funds are subject to volatility.

Conclusion

It makes sense to have a liquid fund in your portfolio. You can opt for larger liquid funds which tend to have lower expense ratios. On the basis of your financial requirements and risk appetite, you should invest in the mutual funds. It should be noted that liquid funds aren’t being invested for higher ROI but safety.