1) What are liquid funds (money market funds)?
Liquid funds are simply debt mutual funds that invest your money in very short-term market instruments that hold least amount of risk. It is an alternative to short term fixed deposits as it provides good liquidity.
2) Where do they invest?
Liquid fund invest in debt instruments such as certificate of deposits (CDs) and commercial papers (CPs) and Money market instruments such as treasury bills, government securities and call money.
3) Are they safe?
Liquid funds can be considered relatively safe, as they possess negligible risk.
4) Will my capital be protected?
Capital is not protected in liquid funds. However, it is relatively safe and 99% there will be no capital loss in these funds due to the small maturity period.
5) Is the return guaranteed?
Return is not guaranteed as the performance of fund depends upon how the market performs unlike fixed deposits which are not dependant on the market.
6) What is the minimum and maximum investment period in liquid funds?
These funds can invest in instruments up to a maturity of 91 days. The maturity is mostly much lower than that.
7) Is there any exit/ entry load for investment in liquid funds?
Generally there is no entry or exit load in liquid funds. But in very few mutual funds, there is exit loads if it redeemed within 1 month.
8) How do liquid funds generate better returns than savings account?
Savings account gives a return of 4% per annum, whereas Liquid funds give a return of around 8-9% per annum. People prefer savings bank account so that they can have liquidity i.e., use these funds whenever they wish to. Liquid funds also provide the same liquidity as the savings account. Hence, liquid funds generate better returns than savings bank account with same liquidity.
9) Can Individuals invest in these securities directly or they should go through funds?
Individual should go through funds as these securities are quiet expensive for an individual to invest in directly.Also, diversification provided in these funds is backed by expert analysis, which is not possible for most of the individuals.
10) What is the return difference between liquid funds and savings bank account?
While savings bank accounts provide an annualised return of 4%, liquid funds provide annualised return of 8-9%. Hence, the difference between the returns of the both is of around 4-5%, which is quite significant.
11) How are liquid funds compared to bank fixed deposits?
Liquid fund is an alternate investment to bank fixed deposits for individuals to park their short term surplus funds. Though the returns generated by both the investment options is around 8-9%, liquid funds offer liquidity higher than bank fixed deposits.On the other hand, while bank fixed depositsare easier to access and offer some degree of principal protection, the higher yield combined with the liquidity and taxation benefits make liquid funds an attractive option. However, liquid funds are not risk-free and an investor must carry out basic checks before investing. Also there is a tax advantage,as at 10% gross return for a fixed deposit you pay 30.9% tax and only 22.1% tax for a liquid fund. However, investors must spread their savings across fixed deposits, savings bank account and liquid funds, by this means enjoying the benefits each of these investments have to offer.
12) What is the minimum investment amount?
Minimum investment amount in liquid funds is Rs.5000.
13) Can I do SIP in liquid funds?
Yes, SIP can be done in liquid funds.
14) How is the tax treatment in liquid funds?
Liquid funds are not tax free. However, they may at best be tax efficient.
We may view liquid funds as inefficient tax vehicles as they suffer from short-term capital gains tax, at your regular tax slab if held for less than a year. Hence, if you are in the high tax bracket, this does hurt. But to handle this there is an efficient strategy.
Consider opting for dividend reinvestment. The dividends stripped will be reinvested as units and will be considered as fresh investments. With a low NAV stripped off dividend and reinvested units considered as fresh cost, your capital gain (sale-cost) will be very low.On the other side, if you are holding liquid or ultra-short funds for over a year, then you may well decide on growth option as you will get indexation benefits.The taxation for these funds would be around 10.26% for long term on your Capital Gains.
You will have to pay capital gains tax and in dividend plan it has dividend distribution tax.If you are in the 10-20% tax bracket better go for growth option. If you are in the 30% bracket then you can go for dividend reinvestment option. This way one can attain tax efficiency on liquid funds.