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What are Liquid Funds?

In line with its name, a liquid fund is a debt market mutual fund scheme that ensures money is available in case of any contingency.

How do Liquid Funds work?

  • Liquid funds invest in debt and money market instruments with a maturity of up to 91 days only. Since these funds are traded infrequently on bond markets and held by the investor till they mature, it helps in mitigating risk arising out of interest rate volatility, provide high liquidity and ensures stable income.
  • Liquid funds invest only in instruments with a high credit rating and their net asset value (NAV) change is mostly dependant on the interest income that the fund accrues.
  • Liquid funds do not have a lock-in period.
  • Liquid funds get the benefit of previous day’s Net Asset Value (NAV). For the investments up to 2 pm on a particular transaction day (subject to funds available for utilisation by 2 pm), the units are allotted on previous day’s NAV.
  • For redemption up to 3 pm on a particular transaction day, the units get redeemed at the same day’s NAV.
  • For redemption of up to Rs 50,000 up to 2 pm, the proceeds get redeemed the same day.
  • On redemption, the proceeds get credited to the bank account the next day.
  • There is no entry or exit load by fund houses in liquid funds.

Why should one invest in Liquid Funds?

  • Good for building a contingency fund
  • Least volatile among mutual funds as they invest in instruments with high credit rating
  • Risk of default is negligible due to short maturity of investment portfolio
  • Remain a good alternative to savings account as they have known to provide better returns.
  • Flexible with investment options like growth and dividend payout with weekly or monthly frequencies. Investors can also use liquid funds to stagger their investments into equity mutual funds using the systematic transfer plan (STP) when the valuations are right.

Liquid Funds and Taxation

Holding Period Income Treatment Tax Implication
Less than 3 years Short-Term Capital Gain Added to income and taxed as per individual’s tax bracket of 10%, 20% or 30%
More than 3 years Long-Term Capital Gain 20% with indexation benefit on cost