Debt funds: Know when you should invest in liquid funds

December 29, 2020 12:15 AM

Investors who typically park their funds in savings bank accounts for lack of low-risk options for the short term should instead go for liquid funds

Investors who typically park their funds in savings bank accounts for lack of low-risk options for the short term should instead go for liquid funds.Investors who typically park their funds in savings bank accounts for lack of low-risk options for the short term should instead go for liquid funds.

By Hemanth Gorur

Liquidity in one’s portfolio is an investment criterion grossly underestimated by the common investor. If your investment portfolio does not have adequate liquidity to manage emergencies, running expenses, and planned contingencies, your financial plans may get thrown off track and you may end up with unexpected losses.

Liquid funds are investment schemes that can offer decent returns at low risk, and can help reach your financial goals smoothly by providing for unexpected eventualities.

What are liquid funds?
Liquid funds reside at the lowest end of the risk-return spectrum of investments. That is, they yield one of the lowest returns as compared to debt or equity funds, but at the same time the risk of losing your principal is also considerably lower. For investors, they are the equivalent of a savings bank account for savers. These funds invest in short term securities with a maturity period of up to 91 days. The securities could be debt or money market instruments. As the maturity term is very short, there is negligible volatility or risk. The return data for these funds are available for periods of seven days, 15 days, and one month also. The Net Asset Value will be available up to four decimal places, for the investor to assess the real returns and volatility, or fluctuations in return.

How to invest in liquid funds
Investors need to take note of the cut-off timings for investing in liquid funds. For purchases and switch-in transactions, the cut-off time is 1:30 pm. For applications received before this cut-off time on any day, the closing NAV of the immediately preceding day will be applicable. If received after the cut-off, the closing NAV of the day immediately preceding the next business day is applicable.

For redemptions and switch-out transactions, the cut off timing is 3:00 pm. If application is received before this cut-off time, the closing NAV of the day immediately preceding the next business day is applicable. If received after the cut-off, the closing NAV of the next business day applies.

For investing in liquid funds, investors need to look at a few parameters. One of them is what is called modified duration. This measures the interest rate sensitivity of the fund. Modified duration of liquid funds should be low.

Another parameter is the fund’s performance against its benchmark index, which could be the CRISIL Liquid Fund Index or the MIBOR of NSE. Finally, investors should watch out for the credit risk taken up by the fund—if this is high, the fund may not be a good option for liquidity.

When to invest in liquid funds
Investors who typically park their funds in savings bank accounts for lack of low-risk options for the short term should instead go for liquid funds. This move may land you 1-3% more returns compared to savings bank returns. At times, liquid funds could offer returns higher than even term deposits or Post Office small savings schemes depending on the prevailing interest rates.

Liquid funds are an ideal investment vehicle when you need to temporarily hold the proceeds of, say, sale of shares or property, before reinvesting in instruments yielding higher returns. They can also offer a safe haven when the market is in turmoil and you need to protect your investments from volatility and potential losses.

You can also make liquid funds a permanent part of your portfolio so as to provide for unforeseen emergencies. But in that case, know that there is an opportunity cost of doing that—you lose out on higher yield instruments once you stay invested in liquid funds for more than 91 days.
Liquid funds are an underutilised but very handy option for investors to earn a few percentage points more than savings bank interest rates at no extra risk and to park their funds for shorter durations as part of their portfolio strategy.

LIQUIDITY RULES

  • Liquid funds are an ideal investment vehicle when you need to temporarily hold the proceeds of, say, sale of shares or property
  • It is a safe haven when the market is in turmoil and you need to protect your investments from volatility and potential losses
  • Investors should watch out for the credit risk taken up by the fund—if this is high, the fund may not be a good option for liquidity

The writer is founder, Hermoneytalks.com

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