What is Liquid Fund? Advantage and Disadvantage of Liquid Fund, How it is different from Fixed Deposit (FD)

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Many times it may come to your mind that what is Liquid fund. Are they safe enough for investment, and are they different from other investment instruments? I will discuss these points in detail in this article.

What is Liquid Fund
What is Liquid Fund

What is liquid fund?

Firstly, let’s understand what a liquid fund is? Liquid funds are a kind of mutual fund. Mutual funds generally invest in equity(shares), whereas Liquid funds are a kind of Debt fund (One type of mutual fund).

Liquid funds don’t invest money in any company’s share, whereas they invest in bonds, government securities, and debentures.

Generally, debt funds offer a fixed amount of return, and the time frame in this type of investment is 2-3 months.

Liquid Funds Meaning

The liquid fund got its name liquid because it can invest in debt instruments for a very short time.

Liquid funds can invest in only that debt instrument which are having a maturity period of a maximum of 91 days. 

Let’s understand Liquid Funds with an example:-

If company A needs a short term loan for 91 or less than 91 days, company A will issue Debentures with maturity time of up to three months.

And the debenture issued by Company A will be subscribed by Liquid fund manager.

Finally, after the maturity period, Company A will pay the liquid fund manager amount of loan with a fixed rate of interest as agreed earlier. 

In this type of instrument, Liquid funds invest their money. In return, they get a fixed amount of return from such investment.

Here, a question may come to your mind that if liquid funds invest for a very short period, how can we invest for long periods in these funds.

We can stay invested in liquid funds for whatever period we would like. The 91 days boundation is for the fund manager.

The fund manager can not invest in any debt instruments with a maturity period of above 91 days.

Suppose the fund manager has invested in Company A debentures. After maturity, he will take the money with interest and invest it in other options.

This process keeps on repeating, and your money will keep on growing.

Liquid fund Exit load(redeem)

The inventor can withdraw or redeem his money as per his need. 

Note:- If you withdraw within seven days, you have to pay a nominal fee.

You can also say that what’s different in this fund, it looks the same as Fixed deposits. So here is a quick Comparison between FD and Liquid Funds.

Disadvantages Of Liquid Fund over FD

Returns

Generally, a Fixed deposit offer returns from 6% to 8%, which are different for different organisations.

Whereas, if we talk about liquid funds, they are almost similar to FD.

From the returns point of view, they are almost the same(But there is fluctuation involved).

Risk

Suppose you are putting your money in reputed banks or nationalised banks. In that case, your money is almost risk-free, or we can also say that zero risk.

Note: From 1st April 2020, your FD amount of up to 5 lakhs is fully insured.

In the case of a liquid fund, we can not say that it has zero risks, but we can definitely say that the risk involved is very less.

And there is a reason behind this: it is easier to estimate the risk for shorter duration investment than a longer period.

So overall, it is not as risk-free as FD is concerned.

Advantages of the liquid fund over FD

Deposit Flexibility

Liquid funds are flexible in terms of investment where you can invest weakly, monthly, or quarterly as per your choice in a single account.

Whereas fixed deposits are a one-time investment, and if you wish to invest again, you have to open a fresh account.

Withdrawal Flexibility

In liquid funds, you can withdraw your money whenever you want. Only, if you withdraw it within 7 days of investment, you have to pay a minor exit load fee.

In FD, some institutions will have a policy of no withdrawal before maturity. In contrast, some institutions will cut down interest by half or one percent.

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