What is liquid fund ? 5 things you must know about it.

Mutual funds are not making money. 

I have been doing sip for 3 years still my returns are negative. 

It has eaten up my hard-earned money, so I do not even want to redeem it. It is really risky to invest in a mutual fund.

This is what my one old friend said when I told him that I am an investment advisor now and I advise on mutual funds and insurance.

I had sympathy for him. There were many like him. Either they were victims of mis-selling or they invested in mutual funds just because their colleagues did that.

So, I asked him, Have you ever invested in liquid funds, if you did not know anything about mutual funds.

He saw me doubtfully, I could see how much he might have suffered due to the loss of capital in his SIP.

And he asked, Now, What is the liquid fund?

I told him, that a liquid fund is similar to your bank savings. It doesn’t fluctuate more like your equity investment.

Because it doesn’t invest in the stock market at all. 

So, where does it invest if not the stock market, doesn’t all mutual funds invest in the stock market? He asked.

I said, no, it is to invest in the money market. It is a type of debt market where corporations and the government raise money to meet their short-term needs. 

So, it earns fixed interest. Your bank savings interests work similarly.

Then he got more interested in this topic and asked me more about it.

I thought many people like him didn’t know the types of mutual funds.

There are many types of mutual funds to cater to your particular financial needs from short-term savings to long-term wealth building.

You should be first clear with your needs and then go for any suitable mutual fund type.

Liquid funds are types of mutual funds that you can use to park your money for a short term like some months.

It is a very useful type of mutual fund that never got well-deserved coverage like equity mutual fund.

So, I thought of writing a detailed post on everything about liquid mutual funds.

After reading this post, I am sure you will be able to understand what is liquid fund. and why you should have it.

 So,

What is the liquid fund? 

I guess, now you might have some idea about liquid funds.

Let us take it a little further.

It is a type of mutual fund. So, just like any other mutual fund, it is also a pool of money.

But here, money is invested in liquid asset classes.

Now, you might be thinking, what is a liquid asset class?

So the answer is, in finance terms, liquid asset means any asset where it is easiest for you to convert it into cash immediately as per your need.

Now, take some examples to understand it.

You invested your money to buy a home or land. Now, due to some emergency, you need money.

Do you think you will get money immediately by selling your home or a piece of land? 

No, you can not. First, it takes time to find buyers and after finding buyers, long regulatory requirements you need to follow.

So it takes a lot of time to get cash from it to make it for your emergency.

Now, according to the definition, do you think it is a liquid asset? 

Certainly not!

Now, imagine the same scenario and your money is in your bank account or you did a fixed deposit of your money.

You can withdraw money immediately from your bank savings, right?

And fixed deposits you can withdraw with some penalties.

But, you will have cash in your hand faster than selling a property.

Now, again the same question. Are bank savings and FD liquid assets? 

Yes, they are.

Back to our liquid funds. Question may arise

How liquid fund work?

In Liquid funds, just like in bank savings or fixed deposits money is invested in some debt instruments for fixed interest rates.

Big corporate houses with good credit ratings and governments raise money for the short term by issuing short-term papers.

Because the paper’s maturity duration is short, like 14 days. Liquid funds are less risky.

But at the same time, against safety, it gives comparatively low returns.

Any good liquid fund would earn you as similar to bank savings accounts interest rates per annum.

What is the difference between a debt fund and a liquid fund? 

Well, a Liquid fund is one kind of debt mutual fund. But the maturity of papers is short, like 14 days.

While there are many types of debt funds.

It can be a short-term debt fund, a medium-term debt fund, or a long-term debt fund.

It just depends on the time duration of maturity of papers where money is invested.

In any kind of debt fund, the income source is fixed interest earned on capital.

The longer the duration of the debt fund, the more the risk of interest rate fluctuation. 

However, in long-term debt funds, you may earn higher interest rates compared to liquid funds.

Because in liquid funds companies with high credit ratings are only allowed to raise money.

High credit ratings mean, those companies enjoy raising debts at low interest rates, but surely your money is in the safest hands in the market.

Which is better? FD or liquid fund?

 The answer is both are best. The more important thing is what is your investment duration.

Both instruments have their pros and cons.

We will discuss it.

Liquid fund is a good instrument if your goal is just to park money for the short term.

Like you are shortly planning to make a big purchase like a car, a home, or planning to buy some shares or gold. 

But, if your purchase is some months away due to any circumstances, then a liquid fund is the best instrument to park your money.

It will earn interest a little bit more than your bank savings. And you can get money in your bank account within a day.

You can withdraw from your liquid fund at any time. And there is no exit load on it after 7 days of investment.

You can not do the same with Bank fixed deposits.

Bank fixed deposits will attract a penalty for premature withdrawal.

So, go for fixed deposits if your investment horizon is 1 year or more than that.

One benefit of a fixed deposit is that it provides a capital guarantee of 5 lakh rupees by RBI, in case of default by the bank.

While in a liquid fund, there is no such guarantee given.

But yeah, chances of such defaults are rare due to high regulations.

If you are a beginner to mutual funds and not comfortable with volatility, then you can start with a liquid fund.

Park your lump sum in a liquid fund, it will give steady returns. 

And later you can move to an equity mutual fund.

How to select a liquid fund? 

Before you start picking a mutual fund, always make sure to see how old the fund house is.

Old fund houses like HDFC, Franklin, SBI, and Nippon are well-experienced in handling liquid funds.

They have a long history of good consistent returns as well 

Now, we will see some interesting details about the liquid funds of selected fund houses. So, here are some liquid funds example

HDFC Liquid fund

Launched in the year 2000, HDFC liquid fund is one of the oldest liquid funds in India. It has approximately 60 thousand crore rupees in assets under management in liquid funds.

And this fund has a history of steadily giving good returns in the line of bank savings account returns.

This fund is considered good with better stability.

SBI liquid fund

This is another big mutual fund house in India. 

SBI mutual fund is the biggest fund house in India in terms of equity assets.

SBI liquid fund has a long history of providing consistent returns.

It was launched in the year 2007 and it has approximately 50 thousand crore rupees in assets under management in liquid funds.

Just like HDFC, SBI liquid fund offers steady annual returns in the line of bank savings accounts.

Conclusion

Go for a liquid fund, if your need is to park money for a short duration. Liquid fund is the best option to park money for some months. But if your goal is to build wealth, then this fund is not for you. Wealth building is possible with equity mutual funds over the long term. Liquid funds can just provide you capital safety which you require in the short run. But along with capital safety, you are also earning some interest over it which may be slightly above the bank savings account.

Now I will answer some frequently asked questions related to liquid funds