Liquid funds - why are they so popular among investors today

Liquid funds are debt funds in which money is invested in a short term pool with the least maturity period, i.e. not beyond 91 days. These are quite popular in the financial market due to its unique name. Let us explore some of the reasons why liquid funds are popular among investors.

1. NAV is non-volatile

NAV stands for Net Asset Value, which represents the per share market value of the fund. Shares are either purchased or sold to a fund company at this price. The NAV of liquid funds is non-volatile because the only change that occurs in the NAV value is the result of interest that incurs. Since it has the least time of maturity, the instruments in which money is invested are hardly traded. Hence, the NAV only sees changes to the income accrued daily and over weekends which is most of the times non-considerable.

2. Fewer interest rate fluctuations

When investors invest in long-term funds, there is a tendency of fluctuations in the interest rate predicted. The investor may incur a loss or may also benefit from a profitable rise in the rate. In the case of liquid funds, there are almost nil chances of fluctuations as they are short term and rely on the low-risk sector for investments. As investments by liquid funds are made in market pools or securities, which have the highest credit rate, the risk of low-credit is lessened as well.

3. High Liquidity

Liquidity defines the ease with which an investor can turn a given asset into cash without increasing or decreasing its value. Emergencies are an unpredictable part of daily life, which a normal person is unaware of. Say, an investor falls into an urgent need of cash and now has to rely on one of his investment funds for it. If he owns many assets but cannot convert those into cash without decreasing their value, then it is a huge loss. As the name says, liquid funds offer liquidity meaning an investor can redeem his investments any time, and the proceeds would be credited to him with 1 or 2 days. The reason for high liquidity is the short time period for which money is invested in these liquid funds.

4. Cost

When a company says “we grant expected returns over your investment” or “your money is safe with us” it increases the curiosity of an investor. When a certain amount of money is invested in a fund, an expense ratio is generated, which is the fee or charge for managing your money. According to the SEBI (Securities and Exchange Board of India), the expense ratio for any liquid fund should be under 2.25%. Considering the shorter time for which the money is held in a liquid fund, the expense ratio is comparatively low. Also, liquid funds offer high returns so you need not spend a bulk of money in maintenance of your fund at the same time it gives high returns.

5. Taxes

Liquid funds are taxed based upon the growth and dividend plans; an investor is given a choice between either of them. If the growth plan is followed then, there are two possibilities –

• If an investor sells out the funds before three years, then tax has to be paid according to the tax slab.
• If funds are held for more than three years, then LTCG (Long Term Capital Gains) tax with indexation is eligible upon them.

If a dividend plan is chosen, then the funds are subject to DDT (Dividend Distribution Tax) of 29.12%.

These were some of the major reasons why liquid funds are so popular among investors. Mostly due to their high-interest return, high liquidity, low-risk and the short time period, they are preferred by investors and financial experts of today.