Liquid mutual funds are one of the most popular investment options for individuals and institutions looking for short-term parking of funds with minimal risk and high liquidity. These funds are designed to provide stability, easy access to money, and better returns than traditional savings accounts.
In this guide, we’ll explore how liquid mutual funds work, their benefits, and why they are an excellent choice for short-term investors in India.
What are liquid mutual funds?
Liquid mutual funds are a category of debt mutual funds that invest in short-term money market instruments such as treasury bills, commercial papers, certificates of deposit, and government securities with maturities of up to 91 days.
These funds are known for their low risk, high liquidity, and stable returns. They are ideal for investors who want to park their surplus funds for a short duration, ranging from a few days to a few months.
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How do liquid mutual funds work?
Liquid mutual funds pool money from multiple investors and invest it in high-quality, short-term debt instruments. The fund manager ensures that the investments are spread across various instruments to minimise risk and maintain liquidity.
Since the underlying securities have short maturities, the fund can quickly convert them into cash, allowing investors to redeem their units with ease.
Key features of liquid mutual funds
- Low risk: Liquid mutual funds invest in highly rated debt instruments, making them one of the safest mutual fund categories.
- High liquidity: Investors can redeem their units within 24 hours, making these funds highly liquid.
- No lock-in period: Unlike fixed deposits, liquid mutual funds do not have a lock-in period.
- Better returns: These funds typically offer higher returns than savings accounts or fixed deposits for short-term investments.
- No entry or exit load: Most liquid mutual funds do not charge any entry or exit load, making them cost-effective.
Who should invest in liquid mutual funds?
Liquid mutual funds are ideal for:
- Individuals looking to park their emergency funds or short-term savings.
- Businesses that need to manage their cash flow efficiently.
- Investors who want to earn better returns on their idle funds without taking significant risks.
Benefits of liquid mutual funds
- Stability: Since liquid mutual funds invest in low-risk instruments, they provide stable returns with minimal volatility.
- Flexibility: Investors can redeem their units anytime, making these funds highly flexible.
- Tax efficiency: For investments held for more than three years, Long-Term Capital Gains (LTCG) are taxed at 12.5% without indexation benefits, as per the Union Budget 2024.
- Low cost: With no entry or exit loads and low expense ratios, liquid mutual funds are cost-effective.
How to invest in liquid mutual funds?
Investing in liquid mutual funds is simple and can be done through the following steps:
- Choose a fund: Research and select a liquid mutual fund based on its past performance, expense ratio, and credit quality of the underlying securities.
- Complete KYC: Ensure your KYC (Know Your Customer) is completed with the fund house or through a registered intermediary.
- Invest: You can invest directly through the fund house’s website or via a reliable trading platform.
Taxation of liquid mutual funds
Those who invest in liquid funds must be aware of the liquid fund taxation to ensure compliance. Capital gains and dividends earned through liquid funds are subject to taxation. Here’s how the tax treatment works:
Short-Term Capital Gains (STCG)
If liquid fund units are sold or redeemed within three years of purchase, the gains are classified as short-term capital gains. These gains are taxed at the investor’s applicable income tax slab rate.
Long-Term Capital Gains (LTCG)
Liquid fund units held for more than three years before redemption are considered long-term capital gains. As per the Union Budget 2024, these gains are taxed at a rate of 12.5% without indexation benefits.
TDS on dividends from Indian companies
Indian companies distributing dividends must deduct Tax Deducted at Source (TDS) at a rate of 10%, provided the total dividend exceeds ₹5,000 in a financial year.
Taxation on dividends from foreign companies
Dividends received from foreign companies are taxable in the hands of investors. Investors can choose to pay tax at a flat rate of 20% (plus applicable surcharge and cess) instead of their regular income tax slab rate.
It is important to note that while liquid mutual funds are a category by themselves, there are other mutual fund categories, such as equity funds, that also play a significant role in an investor’s portfolio. For instance, the Motilal Oswal Midcap Fund is an equity fund that focuses on mid-cap companies and is suitable for long-term investors seeking higher returns.
Conclusion
Liquid mutual funds are an excellent choice for investors seeking low-risk, high-liquidity, and stable returns for their short-term financial goals. These funds offer flexibility and better returns than traditional savings options.
By understanding how liquid mutual funds work and partnering with a reliable platform like Ventura, you can make informed investment decisions and achieve your financial objectives with ease. Start your investment journey today and explore the benefits of liquid mutual funds!