Almost all of us have surplus money parked in a bank
savings account waiting to be used for some unforeseen expense or the other
over an uncertain time frame. It is also one of the safest places to put your
money. You are more than happy cause your principal is safe and liquid and it
is at least earning 4% interest.
Since the expense is unknown and so is the timeframe need
we suggest an option where your money works harder for you and gives you the
same benefit, plus a little more yield than what you will earn in a savings
account.
Enter liquid funds also known as cash funds. They have more
potential than a savings bank account or fixed deposit for that matter. They offer
returns slightly higher than fixed deposits apart from offering the same level
of security. In short, liquid funds can be used as substitute to your savings
bank account.
What makes the cash funds liquid? These funds invest
primarily in money market instruments, such as commercial paper, certificate of
deposits, treasury bills, and call money market for a shorter duration. They
are extremely low-risk and very liquid, meaning that you can change it into
cash assets at any time. Their aim is to secure returns that are better than
bank savings account and more liquid than term deposits. Hence when the
uncertainty over your expense ends i.e. you know when and how much you are
going to need all you need to do is redeem the units which will give you the desired
funds, Liquid funds are mandated by SEBI to process the redemption proceeds
within 24 hours. Investors are advised to do provide for three to four days to
receive clear funds in their bank accounts.
Liquid funds differ from debt funds i.e. the income funds
and gilt funds. The gilt and income funds have a higher maturity profile and
provide superior returns over a long term but are susceptible to interest rate
risk. Since income and gilt funds invest in long term and medium term
instruments, they are more prone to changes in interest rates. Liquidity in
these funds comes at a cost known as exit load. Liquid funds provide returns
less than debt funds and have a shorter maturity profile. But they score over
income and gilt funds in terms of liquidity, as they are no load funds. Liquid
funds are the least risky instruments.
Cash funds are known to provide steady returns with minimal
risk and focus on capital preservation. These funds also cash in the interest
rate volatility, as short-term funds are less prone to changes in interest
rates. Hence such funds are most sought after by the conservative investor who
does not want to trade his principal for a risky return.
What's more, many mutual funds have tied up with banks
allowing direct credit to investors' account implying that the investor need
not go to the mutual fund's office for collecting redemption cheques. This
means that an investor can submit his redemption request on Monday morning
before 10 or 10:30 IST and get a redemption request processed based on the
closing NAV of Sunday and get a redemption cheque on the next working day.
Almost all liquid funds declare NAVs on Sundays and on public holidays. All
this can be done at NAV based prices since liquid funds do not charge any entry
or exit loads. Secondly their anywhere cash facility allows an investor to
redeem his units from any mutual fund's centre other than the place he invested
from.
In terms of taxation, the Budget 2002 has put mutual funds
at par with bank deposits. Liquid funds will be chargeable to tax at individual
taxation rates. Any income above Rs 1,000 would be subject to tax deduction at
source at the rate of 10%. Deduction is also allowed in respect of this income
under section 80 L within the overall ceiling of Rs 9,000. Still the short-term
losses can be offset with short-term gains from mutual funds. In case of bank
deposits, interest income received is eligible for deduction under Section 80L
up to Rs 9,000.
Retired people or people nearing retirement should invest
in liquid funds. Because at this stage, the last thing you want to do is invest
your money in risky propositions. Even if you are an aggressive investor, you
should have some portion of your investment portfolios in money market
instruments or liquid instruments for stability and liquidity. In case you need
some emergency cash, you can redeem your liquid fund with almost no loss to
capital. But one should remember that investments in liquid account do not in
any way insure against loss.
Reference:-
(1) http://www.navindia.com/tutorial/LFund.htm
(2) www.sebi.gov.in
(3) www.nseindia.com
(4)
www.rbi.org.in