Investing in liquid funds

A good avenue to invest for a short term and earn reasonable returns is a liquid fund. Liquid funds are ultra short-term debt funds.They invest in money market instruments such as certificate of deposits, commercial paper and treasury bills, either on an overnight basis, for 10 days or a month. Liquid funds have no entry and exit loads in most cases. These funds can be used to park cash for a short term. These funds are used to earn a definite amount in less than a year.

The income or bond funds have much longer tenures than liquid funds, and therefore have potentially more downsides as also higher returns. They are suitable for medium to long term horizons . Income funds primarily invest in different, longer tenured instruments like corporate bonds and government securities.

Compared to savings accounts, where the returns are as low as four per cent per annum, the historical returns on liquid funds have been as high as eight per cent per annum. Liquidation is easy. Investors can liquidate at a NAV (net asset value) which they consider to be lucrative, as against a normal mutual fund where the NAV just has a notional value. These funds require a minimum investment of Rs 1,000. However, some funds have a minimum investment requirement of Rs 5,000 too.

There are two kinds of liquid funds. One is a pure liquid fund and the other is liquid plus. The main difference between pure liquid and liquid plus funds is the tenure of the securities held. The instruments held by liquid plus funds have a longer tenure than those held by liquid funds. In terms of tax implications, there is a dividend distribution tax of 28.33 per cent on liquid funds, whereas 14.16 per cent is levied on liquid plus funds (in case of individual investors).