Along with saving, it is important to invest prudently

As an individual, we prefer to save rather than invest. While saving is important, it is equally important to invest prudently. With inflation taking its toll on the prices, your savings will not be of much help unless investment in high yielding asset classes. Apart from bank fixed deposits and corporate deposits, equity mutual funds are also an ideal way to build a long-term corpus.

Fixed deposits gives you liquidity and a pre-determined rate of return. Something on similar lines are offered in mutual funds called liquid funds. While there is liquidity, there is no guaranteed pre-determined rate of return in liquid funds. The average return in this product category over the last decade has been over 8.6% per annum. The standard deviation being less than 0.01. With standard deviation so low, the volatility is very less, which helps deliver more predictable returns.

What are liquid funds?

In mutual funds, liquid funds falls in the category of debt mutual funds. Typically, the fund manager of a liquid fund invests in very short-term instruments — commercial paper, treasury bills, certificates of deposit that have a very high credit rating and can be liquidated at a short notice. The maturity of the above instruments can be up to 91 days. Many a times, part of the portfolio can have average maturities of a week or a fortnight, too. Typically, it’s a very low risk investment and can be considered by a new mutual fund investor. It has a very negligible interest rate risk among debt funds and has no entry and exit loads.

When we talk about liquidity, redemptions are processed within 24 hours on business days. When you place a redemption request by 2 pm on a business day, then the funds are credited on the next business day before noon, to your bank account.

Check list

Recently, one of the liquid fund schemes of a mutual fund house had put a restriction on the redemption of the specific liquid fund on account of default by one of the corporate. This risk happened, as the fund manager invested in paper, in which it should not have. The market regulator has put in stringent compliance norms. The size of the fund, credit quality of the portfolio and track record of the fund house must be seen before investing in liquid funds.

Taxation

Investments held for over a period in excess of 3 years, long term capital gains come into picture and the benefit of Cost Inflation Index, is available for the investors. The tax rate is 20% with indexation benefits. This typically increases the yield for the investors. If you are in the tax bracket exceeding 10%, the yield could be in double digits. But then being simple is the most complex part. This also helps in reducing tax outgo for investors in the higher income tax slabs. You will notice that income from earnings of savings bank accounts or bank fixed deposits are clubbed to one’s income and are taxed at respective slabs.

Investments when held for less than three years, short term capital gains is applicable. The taxation here is based on the tax rate category, which the investor is liable to tax.

Liquid funds are one of the most underutilised investment options used by the retail investor. The simplicity of the investment type, liquidity and the ease of investment, need to looked into, in this investment. Again as a short term and very short term investment option (typically between 0-90 days), it provides attractive investment options as compared to a savings bank investment option. An investor should not give it a miss in the mutual fund investment journey.

The author is founder and managing partner of BellWether Advisors LLP