Liquid Funds
The type of mutual fund that you should know about, but probably don’t.
Let’s jump right into this one with an example.
You’re a small fish in a big pond, with aspirations to become one of the big fish and eventually, move to an even bigger pond. And in order to get there, you’ve identified a path. A path that happens to go through a couple of years of work experience, followed by a brief detour for some higher education, and finally, branching out towards the career of your choice.
You’re currently in stage one, racking up quite some experience and along with it money, while preparing for the next stage. And this prep-work also involves saving money. The best practice to save money, is to not just save it, but also, ensure that it grows as well, and you realise this.
So, you head towards the stock market to invest this money, but notice that the markets are all red and shaky, giving you absolutely no confidence that, in the short period of time for which you want to invest your money, you’ll get great returns without losing capital.
Back to the drawing board it is.
What are the options that you have?
Anything dealing with equity markets is out, so no stocks and no mutual funds dealing in stocks.
There are other mutual funds that deal in debt instruments, which are relatively safer, but are designed for more long term investments. So, if you would want to get your money out in under a year, you’d incur additional charges.
Next best option is a fixed deposit, but the rates of interest are insultingly low for such small periods. So that doesn’t make sense either.
What do you do next? Do you just give up and let your money just sit in your account, losing in its fight against inflation, or do you explore a bit more?
If you were to pick the route leading towards exploration, you’d inevitably arrive at something called a liquid fund.
What’s a liquid fund?
You can look at liquid funds as the love child between Fixed deposits and Debt funds.
So what that does that give us?
It gives us an option for investment which has low risk, offers returns that, in most cases are similar or better than those of fixed deposits, and have almost no lock in period.
Let’s address them one by one, as answers through questions.
What do they invest in?
They invest money in bonds of government and private entities, that provide a fixed rate of return, and have a maturity of upto 91 days.
What makes them so safe?
As they invest in short term bonds, for example, a company wants some money to help keep its operations going for a couple of months, after which it would be receiving payments, with the help of which it can fund its future operations. So, it can acquire this short term loan from either banks or bonds. In case banks are hesitant to lend the company money, or for a multitude of other reasons, the organisation comes to the markets to raise money by offering bonds. And, various funds and private investors buy these bonds, which offer to pay the money back within the period of maturity, along with a fixed rate of interest.
So, why are these instruments safe?
- They offer a fixed rate of return.
- Because the period of maturity is so short, the people investing in the bond can easily forecast the future and tell if the company will be able to make the payments or not.
- Plus, these companies are issued ratings, based on their performance, so investors can have a look at those figures to ascertain the safety of their investment.
How do they suit your short term investment needs?
Because these funds invest in bonds with maturity periods shorter than 91 days, they cannot plan for long term investments, like equity funds. That coupled with the constant stream of influx and efflux of money, they are very liquid, and that allows for investors to pull out their money when they please, without incurring any huge charges.
What is the lock in period/ exit loads for such funds?
These funds apply an exit load for investments that are pulled out before seven days.
And still this exit load is very small compared to that of other kinds of funds.
Do liquid funds have no risk?
The risks in liquid funds arise from the company, who’s bonds are held, being unable to repay the principal along with interest to the investors. So, the companies with poorer ratings have greater odds of defaulting on payments, and vice versa.
Also, the poorer the company’s rating, the greater the rate of interest interest its bonds offer. This is because, such companies find it difficult to raise money from banks and therefore look towards private investors and try to woo them with better returns. So, it’s completely upto the fund to design its portfolio with bonds of differing rates of interest and risk levels.
Before investing, have a look at the fund’s portfolio. You’ll see that more risk averse funds will have greater fraction of bonds of government entities, and vice versa.
To summarise it:
If you’re ever stuck in an uncertain situation, where you don’t know if you’d be needing liquid money in the near future, but also don’t want to waste the time by not letting your money grow, then liquid funds would be the way to go.
What you need to know before putting your money into mutual funds
Have you made your first investment yet?
If not, read the series of articles covering why you should invest to how you can get started.
Stock markets can be overwhelming and confusing
Cut through the fluff and quickly make your way towards your first trade
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And, financial literacy is one of those tools. It holds the potential, if harnessed, to change the entire course of a person’s life. Which is why we are working towards making the conversation around it more fun and engaging so that we can empower as many people as we can.
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