With banks reducing interest rates on savings accounts, investors should consider liquid funds for better returns with low risk. These funds invest in short-term debt and money market instruments, offering relatively stable returns along with high liquidity.
Liquid funds invest in instruments with maturities of up to 91 days, allowing them to quickly adjust to new interest rate conditions while minimising volatility. This gives them a natural advantage when interest rates are falling, as the reinvestment happens at prevailing lower rates but without significant capital loss.
While banks are offering 2.75- 3% for savings account balances of up to Rs 50 lakh, returns from top performing liquid funds are around 3.7% for six months, and 7.3% for one year. Although there is no mandatory lock-in, many funds apply a small exit load if redeemed within seven days.
These funds are ideal for parking surplus money temporarily or managing short-term cash flows. Investors often use liquid funds as a parking tool for idle money, especially when transitioning between investments. The liquidity and ease of redemption are significant advantages of liquid funds, as many asset management companies even offer instant redemption facilities up to Rs 50,000 per day, making them highly practical for managing cash.
Predictable returns
Sonam Srivastava, founder, Wright Research PMS, says the short maturity profile ensures that any reinvestment happens quickly at the new, lower yields, but without exposing the investor to mark-to-market losses. “For safety, liquidity, and better returns than a savings account, liquid funds are the more prudent choice,’ he adds.
Reinvestments can be handled systematically through features like Systematic Investment Plans for regular investing, or Systematic Transfer Plans (STPs) for gradually moving funds into other schemes over time. “These tools make it easier to manage reinvestments while keeping the portfolio aligned with overall financial goals and market conditions,” says Nirav Karkera, head, Research, Fisdom.
Through STPs, capital is systematically moved from a liquid fund into equity, hybrid, or longer-duration debt funds. This approach allows for better capital deployment while maintaining liquidity and benefiting from short-term accruals.
Consider before investing
Before investing in liquid funds, it is important to assess your primary objective—whether it’s capital preservation, short-term parking of funds, or managing liquidity needs. Liquid funds are optimal for durations between one week to three months, offering both safety and flexibility. Look at the average maturity and credit quality of the underlying instruments, the fund’s historical performance, and its expense ratio.
Soumya Sarkar, co-founder of Wealth Redefine, an AMFI-registered mutual fund distributor, says individuals must consider those liquid funds that have AAA-rated securities to minimise default risk.
“Stick to established asset management companies with strong track records and consider those funds with a lower expense ratio (ideally below 0.2%) that enhance returns,” he says.
Investors must review the fund’s exit load policy and ensure that the investment aligns with their liquidity needs to avoid unnecessary costs. Note that the capital gains from liquid funds will be taxable as per the marginal rate regardless of the holding period.
