Where Does a Fund Manager Invest My Money If I Opt for Liquid Funds?

Mutual Fund Investments

The asset size of India’s mutual fund (MF) industry has grown 14 per cent to Rs.13.53 lakh crore in FY16, from Rs.11.88 lakh crore in FY15, says an article published in Business Standard in April 2016. MF investments are considered to be an effective tool for achieving short-term and long-term financial goals. Although they tend to be riskier than savings accounts or bank fixed deposits, they offer higher returns.

There are various types of MFs: debt, equity and hybrid. Each type has been further classified, depending upon the investment style, securities they park their corpus in and the maturity period. A liquid fund is a debt scheme that provides the investor an opportunity to earn returns while parking his money in debt and money market securities. This is a good option if you have surplus cash lying idle in your savings account for a time horizon of three to six months.

What are Liquid Schemes?

A liquid fund or a liquid income scheme is one that focuses on the prevention of capital erosion, and invests money in safer instruments like certificate of deposits, commercial papers, treasury bills and non-convertible debentures, says an article by Birla Sun Life Mutual Funds. As the name suggests, a liquid fund tends to have high liquidity.

To ensure liquidity and to avoid market volatility, these schemes invest in securities that have residual maturity of 91 days or less. Such investments offer interest-based returns. They basically have three tyes of plans under them: growth plan, dividend payouts and dividend reinvestment. The dividend payouts are made daily, weekly or monthly. Growth plans do not have dividend payouts and any increment is reflected in the higher unit value.

Benefits

They have a zero lock-in perid or a lock-in period of a maximum of 3 days. Withdrawals are processed as soon as you make a requuest. However, the entire procedure may take 24 hours. Short-term maturity of the assets make these investments liquid. Being highly liquid in nature, they tend to have no or minimal exit load. Also, these are one of the safest debt market investments as they mostly invest in fixed income securities.

Returns

The returns offered by most of these funds are generally higher than those provided by a savings account or short-term fixed deposits. It is especially a good investment option during high inflationary pressure. In such a situation, the RBI keeps the interest rate high to tighten liquidity. High interest rates translate to high returns. The best liquid schemes have returned as high as 7.5 to 8 percent on an average during 2015, daily, on an annualised basis, according to an article published in Livemint in February 2016. Investing in such schemes can help you organize a contingency fund that you access in times of emergency.

How to Invest

Choosing the right time horizon and the right type of scheme is essential to maximize your returns. The type of scheme you choose also determines the tax implications that it might have. Ones that have dividend payouts are subject to dividend distribution tax (DDT) before paying the dividend to investors. The DDT under any debt scheme is close to 28.84 percent (25 percent+10 percent surcharge+3 percent cess). Dividend payout or re-investment works more efficiently if you fall under the 30 percent tax bracket, according to an article published in Moneycontrol in January 2014.

On the other hand, capital gains under the growth option that have been sold within 12 months are taxed according to the investor’s tax slab. This is better is you fall under the 10 or 20 percent tax bracket. Before investing, you must analyze the returns offered by a liquid fund in comparison to both the benchmark index as well as other schemes in the peer group.