Most of us keep our surplus cash in our savings bank account. If we need to use the cash on a regular basis, savings bank indeed is the best option. It is safe and it is convenient. We can withdraw it at any time, using our ATM or debit card. But the question we should ask ourselves is how much are we losing (in terms opportunity cost), to get this convenience. A suitable option for investors is Liquid Fund.
What are Liquid Funds and where do they invest?
Liquid funds are money market mutual funds that primarily invest in money market instruments like Treasury Bills (T-Bills), Certificate of Deposits (CDs) and Commercial Papers (CPs) with the objective of providing investors an opportunity to earn returns, without compromising on the liquidity of the investment. Typically they invest in money market securities that have a residual maturity of upto 91 days.
Liquid funds are very popular among large corporations for parking their surplus funds. However, retail participation in liquid funds is still very low.
Benefits of Liquid Funds:
- High liquidity: Most liquid funds do not have any exit load and redemptions/withdrawals from liquid funds are processed within 24 hours on business days.
- Higher returns than savings bank: Liquid funds normally give higher returns than savings bank. Savings bank interest rate is around 4% (some banks offer slightly higher rates, subject to a minimum balance), calculated on daily balance and compounded monthly. CRISIL Liquid Fund Index has generated 9.21% pretax returns over the last 1 year period (31st December 2013-31st December 2014).
- Low volatility: Liquid funds are less volatile than longer term debt funds, since the underlying securities in their investment portfolio have short durations.
- Tax efficiency:If liquid funds are redeemed within 3 years, then capital gains are taxed at the applicable income tax slab rate of the investor. Dividends from liquid funds are tax free in the hands of the investors, but the fund houses have to pay a dividend distribution tax of 28.325% **before distributing dividends to the investors