What are liquid funds?

My article explaining liquid funds in Mid-day Gujarati today:

Understanding liquid funds

The English translation is given below:

According to a lot of people, all mutual funds are equity funds. One of the reasons behind this myth is the regular risk line that appears in all mutual fund communications, “Mutual fund investments are subject to market risk.” The words “market risk” have a very strong association with equity. So many investors have heard of equity markets, very few know about debt markets or money markets.

This is why not many know of the largest category among mutual funds – the liquid funds. This is a category of funds that helps one park money for very short periods.

If you are running your own business, there are periods when some surplus may be lying in your current account with the bank. This may be shifted to a liquid fund. So let us understand what liquid funds are and how these work.

Liquid funds invest in debentures with very short maturity. Earlier, these liquid funds used to invest in debentures with maturity less than 18 months to 2 years, with average maturity of less than 6 months. However, according to recent SEBI guidelines, liquid funds can invest in instruments with maturity not exceeding 90 days. Such guidelines only ensure that when the investor is looking at a liquid fund with a very short term view, the underlying investments also should be of short maturity.

What does the above mean to an investor? Well, an investor who needs to invest money for a period as short as 2 days can consider liquid funds. The liquid fund offers higher returns than interest paid on the savings account with instant liquidity and high safety of capital. Ever since liquid funds came into existence more than a decade back, there have been only two instances when the NAV (NAV of a mutual fund is the realisable market value of units) of some of the liquid funds were lower than the previous day. This shows us how low is the probability of losing money in liquid funds even for a single day. One must remember that the decade has been marked with certain periods of crisis never before witnessed by the present generation.

What are some of the applications of these liquid funds?

For starters, any money lying idle in a bank account for more than a week should be put in a liquid fund. I know of a friend, very money savvy, who used to purchase his monthly household items using his credit card, while simultaneously putting equivalent amount of money in a liquid fund to be withdrawn couple of days before the credit card bill payment date. This allowed him to earn even on the money he had spent. However, one must be very careful with such a strategy as missing the date with the credit card could be a lot costlier than what one can earn through the liquid funds.

Another application of liquid funds is ideal for businesses – be it small or large. In businesses, the cash flows are highly uncertain and hence periodically the business may end up with huge surplus. Such money can be invested in a liquid fund as it allows the flexibility to invest money for period as short as two days to as long as forever. When one is not certain when the money would be needed, liquid funds are the ideal choice.

Large companies with surplus cash also invest idle money in liquid funds, which is withdrawn when there is a need for capital investment, acquisition, business expansion, etc.

In the heydays of IPOs (Initial Public Offering) by companies raising money from the stock markets, many investors used to roll the money over from one IPO to another, either the money received as refund or the realisation on sale of shares on listing. The money lying idle between such opportunities was parked in liquid funds.

As mentioned earlier, liquid funds offer marginally higher return compared to savings bank account with high degree of safety.

Please remember that investment in liquid fund is all about convenience rather than returns. Your primary need is to get money when you need. Over last few years, mutual fund companies have introduced certain innovative practices to make it even more convenient. We have a facility to transact in liquid funds with the help of SMS or Internet. Some funds offer a debit card facility along with your liquid fund account. You may go to a bank ATM and withdraw money as required directly from your liquid fund account.

Choose a mutual fund advisor who can help you with multiple transactions in liquid funds. Check with one before you start the relationship.

You need not spread your money across many funds, one may be enough.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.