I have some savings in my bank account. I do not want to put the money in fixed deposits. How should I invest in liquid funds and withdraw whenever I need it? What are the risks of losing the principal amount in such funds?
Liquid funds invest in short term debt instruments with maturities of up to 91 days. Bond investments are typically subject to two key risk factors, namely interest rate risk and credit risk. Interest rate risk relates to the effect of changes in market interest rates on the price of a bond. Bond prices and interest rates share an inverse relationship, i.e., if market interest rates move up, bond prices would move down. Further, longer the tenor of a bond the more sensitive is its price to interest rate movements. Credit risk is the risk of default, on either interest or principal payment, by the bond issuer.
Since liquid funds invest in short term debt instruments, interest rate risk is negligible and typically only very sharp movements in interest rates (movements of more than 2-3% over short periods of time like a few days) would affect NAVs of such funds. Further, debt instruments, particularly those issued by corporates and other non-government entities, that liquid funds invest in, are subject to
credit risk. Asset management companies (AMCs) mitigate credit risk by investing in instruments with superior good credit quality and holding a diversified portfolio of securities. Historically, incidents of defaults in securities held by debt mutual funds have been minimal. One can
invest and withdraw from liquid funds either through a physical application form or various online platforms. For redemption requests in liquid funds, AMCs typically despatch/credit the proceeds within one to two business days of receipt of the request.
The writer is director, Investment Advisory, Morningstar Investment Adviser (India)
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