What Is Liquid Mutual Funds And How It Works?

 

Liquid mutual funds are a subset of debt mutual funds that primarily invest in short-term money market instruments. These instruments include treasury bills, commercial papers, bank certificates of deposit, and other debt securities with a residual maturity of up to 91 days. Liquid mutual funds are designed to provide investors with higher returns compared to traditional savings accounts while maintaining easy access to the invested funds.

One of the primary features of liquid mutual funds is the high level of liquidity. Investors can redeem their investments within a very short period, usually within one business day. This makes liquid mutual funds an attractive option for those who want to park surplus funds for short durations without compromising on liquidity. Moreover, these funds usually offer better returns than savings accounts. For instance, if a liquid mutual fund offers an annualized return of 6% and you invest ₹10,00,000, you can expect to earn approximately ₹60,000 over the course of the year, subject to market conditions.

Another primary characteristic of liquid mutual funds is safety. Since these funds invest in high-quality, low-risk money market instruments, they tend to have lower credit risk compared to other types of mutual funds. However, it is crucial to note that these funds are not entirely risk-free. There is usually a lower risk of capital loss as liquid mutual funds invest in instruments with high credit ratings.

Furthermore, the primary benefit of liquid mutual funds lies in their tax efficiency. Gains from these funds are treated as long-term capital gains if held for more than three years and are taxed at 20% with indexation benefits. For holding periods of less than three years, gains are treated as short-term and are taxed as per the investor's applicable tax slab.

Let's consider an example: If an investor were to invest ₹1,00,000 in a liquid mutual fund that yields an annual return of 5%, the value of the investment after one year would be ₹1,05,000. If this investment is held for less than three years, the gain of ₹5,000 would be added to the investor's taxable income and taxed according to the income tax slab rates applicable.

In conclusion, liquid mutual funds serve as an excellent financial instrument for investors looking to manage their short-term liquidity needs while aiming for better returns than traditional savings options. However, investors must gauge all the pros and cons of trading in the Indian financial market before making investment decisions.

**Disclaimer:** Investments in mutual funds are subject to market risks. Read all scheme-related documents carefully.