Liquid mutual funds: Meaning, benefits, and how are they different from index mutual funds 

Liquid funds are a variant of debt funds that predominantly invest in debt security instruments having a short-term maturity of up to 91 days. Such debt securities are commercial papers, treasury bills, deposit certificates, government securities, etc. The basic benefit of opting for a liquid mutual fund investment is it comes with a high liquidity feature. 

Discussed here are some common benefits of a liquid mutual fund, which you must be well-versed with before investing. Also mentioned are instances for which you may consider liquid mutual funds and how they are different from index funds. 

Benefits of liquid mutual funds

• High liquidity

Due to the short-term maturities of underlying debt instruments, liquid mutual funds are liquid in nature, as the name suggests. You can liquidate your invested capital and earned returns based on your convenience. Also, there is no lock-in period on your liquid fund investment. 

• Flexible holding

You can invest and hold your liquid mutual fund investment for as long as you want. This flexibility to enter and quit your investment while generating safe and satisfactory returns not just makes it a perfect instrument for parking your emergency fund but also allows you to meet your short-term financial goals. 

• Low risk 

As mentioned above, a liquid fund’s investment portfolio contains short-term debt securities. The highest maturity period of any security that the fund invests in is three months, which protects the portfolio of most liquid fund schemes from any interest rate fluctuation.

• Higher returns compared to bank fixed deposits

Liquid mutual funds have gained high popularity among retail investors owing to their potential to endow a higher return than a savings account or bank fixed deposit. In the past few years, some of the best-performing liquid mutual funds have delivered a return that is considerably higher than the returns offered by most savings bank accounts. 

When is the right time to make a liquid fund investment?

Financial advisors suggest liquid funds if you are looking to park your idle money for a short time period to earn slightly higher returns than a savings bank account or fixed deposit. You can even consider this financial option to shift your funds from equity mutual funds, bit by bit, using STP (systematic transfer plan) when you are nearing your financial goal. Routing for this strategy allows you to safeguard your generated returns in equity mutual funds from market volatility and meet your financial goal on time.

How are liquid funds different from index funds? 

Index funds invest in stocks that basically imitate a stock index like the BSE Sensex, NSE Nifty, etc. They are passively managed funds, meaning the fund managers in this fund invest in securities that are present in the underlying index in almost the same proportion and do not change the portfolio composition. However, liquid mutual funds, as mentioned above, invest in debt instruments and money market securities having up to 91 days of maturity. So, on the risk aspect, liquid mutual funds are less risky than index funds owing to their investment in debt securities.  

Wrapping up

Liquid mutual funds are a great option when you want to preserve your capital while also earning some returns on it. For goals that are less than six months away, liquid mutual funds are a recommended investment vehicle to park your funds in. For goals that are more than six months away, you can consider other types of debt mutual funds such as short-duration funds.