How to use liquid mutual funds to your advantage

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liquid mutual funds

Liquid mutual funds as the name suggests are those which have a portfolio of very short-term debt instruments, mainly below 91 days. Such portfolio is to maintain the liquidity and safety of the investments. It is considered as the safest category in mutual funds, as it does not invest in long term bonds, and thus does not get affected much by interest rates movements.Thus it is meant to park money for a very short time frame.

Another similar category of funds are Ultra short term funds which were earlier known as Liquid plus funds. These funds in comparison to liquid funds have a slightly longer tenure portfolio. Like Liquid funds, these funds also invest in less than 91 days papers, but a small portion of the total investments can be made in longer tenure papers.

Liquid funds and ultra-short term funds are mainly used by corporates to park the surplus they have in their current account, as latter are sans interest, and in liquid funds, they get some gain.

At the retail level, liquid mutual funds are not very popular. They get compared with bank deposits like saving bank account and fixed deposits, which are a fixed interest instruments, so at the personal level people prefer parking funds in bank accounts only.

This is also because of the lack of awareness on how to make best use of these funds at personal finance level. This article is about different ways one can make use of Liquid and ultra-short term funds

  1. Emergency fund:

Liquid/Ultra short term funds are best instruments to accumulate and maintain an emergency fund. An Emergency fund should always be kept separate from other regular deposits. Though interest is not a consideration in deposits meant for an emergency but there is no harm in earning on the same if the basic requirement of safety and liquidity is being taken care of.

The other main consideration in an emergency fund is the liquidity aspect. It should be into investments that can be liquidated easily, so emergency requirements can be managed.

Investment in these liquid funds will always be a separate account folio, and thus will not get mixed with other deposits. The return of the instrument depends on the debt market forces and market interest rates. The last 1 year returns of these funds have been in the range of 7%-8%, and these will always remain in the comparable range to bank deposits for that particular time period. So the separation of funds and interest earnings is not a concern with these funds.

Liquidity-wise there used to be an issue with these funds. As Investor needs to put the redemption request on a working day before cut off time and redemption proceeds will get credited in the bank account on next working day. Thus there could be an unacceptable delay in case of extreme emergencies. But nowadays with the technology advancements, these issues have been sorted out.

Now some mutual funds have come up with a debit card which can be used to withdraw cash or can be used at POS swipe machines to make immediate payments. Some fund houses have announced instant withdrawal facility from liquid funds, through which you get your redemption proceeds in a maximum of 1 hour time, and on any day including  nonworking days too.

Where the majority of the banks give 4% interest on saving bank account, and fixed deposits have different slab rates, these Ultra short term funds can be a good investment alternative. Also, the instant redemption feature makes it more attractive for use as for emergency fund.

  1. Provisioning for annual payments:

Liquid funds can be used as a useful tool to save or provision towards annual expenses and also in personal budgeting. Look into your cash flow and you will find some expense heads which are not monthly, but quarterly or annual. For e.g. your insurance payments (Life, health, Car, home etc.) are paid on annual basis, Your vacations frequency is also not monthly, children school fee may get due on quarterly basis…and so on.

It’s always better to make provision for these expenses from your regular income so you should be able to pay them conveniently whenever they get due. Money kept in regular bank accounts is prone to be spent on unnecessary things. By making monthly provisions for annual mandatory/fixed expenses you put yourself into a discipline and can get better control on your cash flows.

This way you can put yourself on a strict budget too, like if you say that Rs 100000 is the amount you spend on your vacations then you should start transferring Rs 8300 on monthly basis into your liquid fund account, and limit your spending with in this budget only.

  1. Strategize the STPs:

Systematic Investment Plan or SIPs is a well-known term among Investors, but Systematic Transfer Plan or STPs has not gained much attraction yet.

Where SIPs are linked to your bank accounts, and make you invest a fixed amount into a specific mutual fund on monthly basis, there in case of STPs, you park lump sum money into a liquid or ultra-short term fund, and a fixed amount as per your instruction will get transferred in your choice of fund on daily/weekly/fortnightly or monthly basis.

Both SIP and STP is meant to average out the cost of investment, but in the case of STP you have more frequency choices available.

Moreover in case of STP, since this is internal to fund house you can strategize your purchases. Like some fund houses offer the feature of flex STP where more money will be transferred to your choice of funds if markets have fallen below a specific level. Some come with a trigger feature too, which redeems your investment to book profit and transfer back to liquid fund when your investment value has advanced to a specific level.

Nowadays one AMC has come up with an Interesting feature of PE based STP, where more funds will be transferred from liquid to the other if the market valuation based on PE multiplies is low, which means that more purchase when markets are fairly or lower valued.

Conclusion:

Mutual funds are the products which have answers to all yours’ investment requirement. It is up to you how you use it. These are much flexible to use in comparison to the other traditional bank instruments. Use it wisely to your advantage.

This article -“How to use liquid mutual funds” was originally published in money control on 7th dec 2016

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He’s MBA ( Finance) gold medalist, a CERTIFIED FINANCIAL PLANNER and SEBI Registered Investment adviser. An ex banker , having a decade long experience in financial services industry he manages clients across the globe. He is a regular contributor to various leading Media and publication houses. He keeps on writing for Moneycontrol, Dainik bhaskar, Business standard etc. He also delivers training on Various personal finance topics to various corporate houses. You may get in touch with him at [email protected]

12 COMMENTS

  1. Hi, great article on investment. I am a prospective investor and was wondering, is cibil score important for investors as well because it is a dreaded word in the borrower’s community?

  2. Nice Article!
    I have used same funda for emergency fund. I kept 50000/- in my savings account (Linked FD) and rest of the emergency fund I invested in Ultra short term fund.
    Could you please suggest some good Liquid fund where we can invest online? Also, let me know the tax implication if we redeemed before 1 year.

    Thanks,
    Deepa

    • Thank Deepa. You can consider Franklin India ultra short-term fund, Birla Sunlife floating rate fund … both are good ultra short term funds. These funds comes under debt taxation, means short term if redeemed before 3 years and long term if holding is more than 3 years. Short term gain will be added in your total income and taxed as per IT slabs, and long term is taxed at 20% after indexation

      • Thanks Manikaran! I have already invested in Franklin India Ultra Short term fund. I will park some emergency fund in Birla Sunlife floating rate fund as suggested by you. Thanks once again! 🙂

        • You are Welcome Deepa. But why you want to spread emergency fund in different Mutual funds. I think one should be enough.

  3. Very good article once again..
    Can you please throw some light on the taxation part also?
    Like how is the income earned on these funds are treated ?
    Thanks.

    • Thanks Ajay. These funds comes under debt taxation, means short term if redeemed before 3 years and long term if holding is more than 3 years. Short term gain will be added in your total income and taxed as per IT slabs, and long term is taxed at 20% after indexation

    • Rishika, Yes you can start with liquid funds. But since it is meant for very short term investments, so you may save for your very near term goals in Liquid funds. Going forward, you should gain some exposure in equity oriented funds too for your long term goals. You may take help of some financial planner, who can handhold you in your investment journey.

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