With goals like purchasing a car, home appliances, children’s education coming up in the near future, liquid funds make for an ideal investment option to park funds meant for such short-term needs. In this article, we discuss the key aspects of liquid funds and why they are suitable vehicles for achieving short duration financial goals.
What are liquid funds?
Liquid funds, also known as money market funds, are open-ended debt schemes that invest primarily in cash, bank CDs and treasury bills with remaining maturity up to 91 days. They aim to provide high liquidity and preservation of capital while offering marginally higher returns than bank fixed deposits. With no exit loads, funds can be redeemed easily as and when required for goals.
Low risk and high liquidity
Given their focus on investing in safer short-term debt, liquid funds carry very low credit risk. Due to the short maturity of underlying assets, they are less interest rate sensitive compared to long duration debt funds. This makes liquid funds one of the least risky mutual fund categories. Their high liquidity from one business day redemption further makes them suitable for parking funds with short horizon of 1-3 years.
Higher post-tax returns than FDs
The pre-tax yields offered by liquid funds are comparable to bank fixed deposits. However, liquid funds score over FDs on post-tax returns due to indexation benefits. Long term capital gains tax of just 20% with indexation on gains over Rs. 1 lakh makes them far more tax efficient than interest income from FDs which is taxed at marginal rate. This boosts their attractiveness for short and medium term goal based savings.
Determines appropriate SIP amount
For goals with timelines of 1-3 years, investors can use an SIP calculator to determine the appropriate monthly contribution required in a liquid fund. Factors like goal amount, expected annual returns, number of years are fed to calculate the ideal SIP amount. An SIP approach helps benefit from rupee cost averaging and stay on course to accumulate the targeted amount systematically over time.
Ideal for emergency funds too
Liquid funds are an excellent place to park emergency funds meant for unforeseen contingencies that may arise in the near future. With instant access to funds, they offer required liquidity while still earning better returns than a regular savings bank account. A 6-12 month expenses corpus in a liquid fund ensures safety of capital and meets any financial emergencies promptly.
Uses of liquid funds for goals
Some suitable short-term savings goals where liquid funds can play an important role include
- Down payment for a car – 2-3 years
- Home appliances/furnishing – 1-2 years
- Children’s education – 5-10 years
- Family vacation – 1-2 years
- Short term goals of 2-3 years
Assessing liquid fund performance
When selecting a liquid fund, investors must analyze key performance metrics like returns over 1, 3 and 5 year periods and compare them against other liquid fund and benchmark categories. Top funds aim to offer higher risk-adjusted post-tax returns while preserving capital especially during volatile markets. Consistent performers point to strong portfolio management processes.
Conclusion
With their focus on capital safety, high liquidity and tax efficiency, liquid funds make for an ideal investment vehicle to help accumulate funds for short term life goals ranging from 1-3 years. For investors with such financial objectives coming up in the near future, liquid funds should form an integral part of their asset allocation strategy.
