An outline of how liquid funds work and how to invest in them
While many of us believe in making wise investments, not all of us have a high-risk appetite. We may not be comfortable with the idea of parking our funds for the long term either. For millions of investors who hold such beliefs, investing in liquid funds, a type of debt mutual fund, can be a great option.
Let's use an example to understand how liquid funds work. Let's say the central government needs to raise funds to carry out some massive infrastructure project. Since it doesn't have enough funds for it, it issues Treasury bills or T-bills. Retail investors, financial companies, banks, trusts, other entities will invest in these T-bills by buying them at their discount value. The issuer- the central government- will inform the bidders (the potential investors) of the discount price, the maturity date, and the T-bill's face value beforehand. This information exchange ensures transparency. Any government-backed security is considered as one of the safest fixed-income investment. That's because it is highly unlikely that the issuer will default on it. Once the T-bill matures, the investor can redeem the T-bills and receive the face value amount.
Apart from T-bills, liquid funds include commercial paper, government securities, certificate of deposit, amongst others. Liquid funds generate income primarily through interest payments on the holdings, and capital gains.
Next, let's understand how to invest in liquid funds.
If you are interested in investing in liquid funds, here are a few considerations before you begin your liquid fund investment:
Although it is a reasonably safe bet to invest in liquid funds, it is only wise to ensure that your portfolio includes different types of securities. In case one of these default, then your investment doesn't take as big a hit as it would if your portfolio had only one type of security.
While you enjoy the returns on your liquid fund investment, remember that there is also an annual fee. Since it is a passively managed fund, and the RBI regulates the expense ratio, this ratio is not too high that it will significantly cut into your gains. Still, it is a factor to be considered before you decide in which liquid fund scheme to invest.
Check the returns on maturity for all the liquid funds you are considering. Also, check out the funds' performances for the past years. This information will help to assess their performance and consistency.
If the big institutional investors suddenly redeem their investment in small-sized liquid funds, it will lead to a substantial loss of assets, and the funds' ability to generate returns. Think about liquid funds which have more significant assets under management, so that even if one big investor exits, your returns are not significantly affected.
Great, now you are more aware of what you need to be looking for in a good liquid fund.
The first step is to find out and ensure that you are mutual funds KYC compliant. As per SEBI, you need to update KYC documents separately for any mutual fund account irrespective of your bank or broker.
In case you are not KYC compliant yet, follow these simple steps to become one:
Now that you have received the go-ahead from SEBI, you can invest in liquid funds.
If you prefer the comfort of your couch, you should use your smartphone to start investing in liquid funds. Follow these steps:
Step 1: Download your bank or AMCs app and register your ID and password.
Step 2: Complete the Aadhar/PAN and biometric verification by following simple instructions.
Step 3: Go to the investments menu and select 'Mutual Funds'.
Step 4: Start investing from anywhere at your convenience.
Liquid funds are great for the short-term or in an emergency. You get steady returns at minimal risk. If you are worried about credit quality, you need not be with DBS Bank. Through the digbank app, you have access to best-rated schemes all in one place.
Download digibank to get started!