Liquid fund is a category of mutual fund which invests primarily in money market instruments like certificate of deposits, treasury bills, commercial papers and term deposits. Lower maturity period of these underlying assets helps a fund manager in meeting the redemption demand from investors.
Benefits of liquid funds
These mutual funds have no lock-in period.
Withdrawals from liquid funds are processed within 24 hours on business days. The cut-off time on withdrawal is generally 2 p.m. on business days. It means if you place a redemption request by 2 p.m. on a business day, then the funds will be credited to your bank account on the next business day by 10 a.m.
Liquid funds have the lowest interest rate risk among debt funds as they primarily invest in fixed income securities with short maturity.
Liquid funds have no entry load and exit loads.
Returns from liquid funds
Liquid funds are among the best investment options for the short term during a high inflation environment. During high inflationary period, the Reserve Bank typically keeps interest rates high and tightens liquidity, helping liquid funds to earn good returns.
During the past year, some liquid funds have even offered higher returns than bank fixed deposits, which levy a penalty on premature withdrawal.
How to choose a liquid fund
The returns from liquid funds don’t vary much as they invest in similar underlying securities. However, when looking for a liquid fund, the past return should not be the only factor for consideration. Other factors like size of the fund, credit quality of underlying securities and track record of the fund house should also be kept in mind.
Tax Implications on liquid funds depends on the holding period.
In case of holding period of liquid funds is more than 3 years, it is treated as long-term capital gain and tax is payable at flat rate of 20% with indexation benefit (inflated cost of purchase).
If liquid fund is held for a period less than 3 years, than the gain is short-term capital gain and is taxed as per your tax slab.
Dividends received under liquid plans are not taxed at the hands of resident individual investors but fund houses pay dividend distribution tax @28.325 per cent (including surcharge and cess).