Liquid funds are a specific type of debt mutual funds. They invest in money market instruments and very short-term debt securities, typically with maturities under 91 days. Liquid mutual funds serve as a popular haven for parking surplus cash; the idea is to get a bit more return than in a savings account while maintaining near-immediate access to funds.
However, not all liquid funds are the same. Here’s a simple guide on how to choose the best liquid fund for your needs.
1. Define your investment objectives
Before selecting any investment, the key question is always “Why?” Why are you investing in a liquid fund? Consider these factors:
- Investment goals: Are you saving for a short-term objective, like a down payment in a couple of months? Or is this simply excess cash you want to protect and slightly grow?
- Time horizon: How long are you comfortable having your money invested? This helps determine if a liquid fund is suitable at all.
- Liquidity requirements: How likely are you to need these funds suddenly? Liquid funds are designed for high liquidity, but there might be slight variations between funds and minor exit fees if you withdraw extremely quickly.
2. Assess the fund’s investment strategy
Every liquid fund has a stated investment strategy. Understanding how the fund will deploy your money is vital. Look for these aspects:
- Portfolio diversity: A well-diversified liquid fund minimises risk. Avoid funds concentrated in just a few assets.
- Average maturity: This indicator reveals how sensitive the fund might be to changes in interest rates.
3. Research and compare
With investment goals clarified, it’s time to find liquid mutual funds that match your needs. Here’s how:
- Past returns: Review a fund’s performance during different market conditions. Consistency is key.
- Expense ratio: Fund management fees impact your returns. Lower expense ratios are generally better for liquid funds.
- Fund manager and history: A good track record from both the manager and the fund company installs confidence.
4. Analyse the risk-return profile
Liquid funds are considered relatively low-risk investments. However, there are slight differences between how fund managers may approach them. Choose the risk level that suits you:
- Conservative vs. aggressive: Some funds take slightly more risk by investing in potentially higher-return (but marginally riskier) assets. Understand the balance the fund strikes.
- Impact of market fluctuations: Even minor economic changes can slightly affect liquid fund returns. Evaluate the fund’s historic susceptibility to such variations.
Additional tips for choosing liquid funds
- Taxation: Be mindful of how short-term and long-term capital gains taxes will apply to your liquid fund earnings so they don’t eat into your profits.
- Exit loads: While most liquid funds do not have them, be sure to clarify any potential withdrawal fees if your circumstances unexpectedly change.
- SIP option: If you intend to regularly add to your investment, some liquid funds offer Systematic Investment Plans (SIPs) that can automate this process.
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Final thought
Investing is always personal. The best liquid fund depends entirely on your unique needs and comfort with risk. Thoroughly understanding your goals and carefully researching the funds out there will lead you to the ideal choice for preserving your surplus cash while earning suitable returns.
