What are Liquid Funds?
A liquid fund is a type of mutual fund which invests primarily in money market instruments, like treasury bills, commercial papers, certificate of deposits, and term deposits. They allow investors to park their funds for a few days or months as they have maturities up to 91 days.
Liquid funds can be made liquid at any time and earn returns for the holding period. Because they earn a return from market instruments, liquid fund’s returns can rise or fall depending on the market rates. For very short debt, Market interest depends on the liquidity situation.
What are Fixed Deposits?
A fixed deposit (FD) is a financial instrument provided by banks, that provides investors with a higher rate of interest than a regular savings account, until the given maturity date. The defining criteria for a fixed deposit are that the money cannot be withdrawn from the FD, as compared to a recurring deposit or a demand deposit before maturity.
The level of liquidity is very low. To compensate for the low liquidity, FDs offer higher rates of interest than savings accounts. The longest permissible term for FDs is 10 years.
Comparison For Liquid Funds Vs Fixed Deposits
- Liquid funds are easily accessible as compared to bank FDs. Bank FDs would penalize you for pre-mature withdrawal.
- Liquid fund returns in the last three years have been quite impressive as compared to fixed deposits. But going forward market liquidity could decide rates.
- They do not have entry or exit loads.
- Lowest interest rate risks, as they invest in short-term fixed-income debt securities.
- Highest return compared to fixed deposits. It would range between 4% to 8% per annum.
- Liquid funds come with various plans like growth plan, dividend plans, daily dividend plans, weekly dividend plans, monthly dividend plans, etc
- Investors can invest in direct plans as they contain a low expense ratio and provide high returns.
Which One is Better?
|1. Returns||Liquid funds invest in short-term securities and offer returns ranging between 5% to 8% per annum. On the other hand, bank fixed deposits offer 5% to 6.5% returns per annum, depending on the tenure. Lower the tenure, interest rates are lower. Liquid funds score higher compared to fixed deposits, for a short-term period of less than 1 year. If you invest for more than 6 months, the returns would be almost the same.|
|2. Tax treatment||If you sell a liquid mutual fund before 3 years, any returns need to be added to your income and you need to pay income tax based on your tax bracket. Hence, no change in tax treatment of liquid growth plans vs fixed deposits for short term.|
|3. Redemption||If you sell your liquid funds, you will receive the funds in your bank account on the same day or the next day, in the morning depending upon the time of redemption. On the other hand, fixed deposits closure can be done immediately. Most of the banks credit the funds immediately within the same day or the same hour.|
|4.Interest Rate Risk||Since liquid funds invest in short-term securities, RBI rates have an impact on such securities. On the other hand, bank fixed deposits also have an impact on interest rate risks. Most of the time, both go hand in hand, sometimes, banks do not charge any interest rates due to minor RBI rate changes.|
Related article :- Postal Recurring Deposits Vs. Mutual Fund SIPs
If you want to park your money for a short term of 1 to 6 months, liquid funds would be the best bet for you. Consider the above factors before investing in such funds.
Debt mutual funds invest in fixed income securities like bonds, treasury bills, government securities, Money Market Instruments, and any other debt instruments. Such debt mutual funds are available in the form of Monthly Income Plans (MIP), GILT funds, Fixed Maturity Plans (FMP) etc.
Debt Mutual Funds are different from regular equity mutual funds and offer various other advantages which seldom are known. This article will sum up everything with respect to Debt Mutual Funds and its relevance in current scenario.
How debt funds are advantageous and when?
Capital gains are long term only if the debt mutual funds are held for 3 years or more. If you want efficient-taxability of the capital gains on mutual funds, then you can be invested in mutual funds for the period of 3 years or more. Such long-term capital gains are allowed benefit of indexation and 20% tax rate is applied after such indexation. Hence, these funds can be used as tax management tool for those who are in high tax bracket.
Market linked returns
Debt mutual funds generate superior returns as compared to other conventional fixed income securities, especially where the interest rates are falling. Reserve Bank of India is cutting rates from quite some time now and in recent monetary policy it changed it’s accommodative stance to neutral by keeping repo rate unchanged at 4%. Looking at falling interest rate scenario, we have experienced that this has resulted in reduction of interest rates of bank fixed deposits. On the contrary bond prices have risen as they have inverse relationship with interest rates. This will lead to increase in returns from the debt mutual funds. Since there won’t be major interest rate rise in coming future, debt mutual funds can be a safe bet for risk adverse investors to earn better returns as against bank fixed deposits etc.
Better liquidity as compared to bank deposits
Bank deposits are not transferable and cannot be withdrawn partially or even are levied premature withdrawal charges for premature full withdrawal. Debt mutual funds stand in a better position with respect to liquidity as it can be partially redeemed or withdrawn. However, keep a check on exit load within lock in period which may be between 6 months to 3 years. Some of the debt funds levy exit load of 0.5% to 2%, if redeemed or sold within lock in period.
Superior returns and moderate risk
Since, falling interest rates make debt fund returns look good, these funds can even give you more than bank fixed or recurring deposits, at slightly higher risk than conventional bank deposits (due to interest rate risk).
Even in case of global economy impact on domestic economy, the investor can minimize such incidence of global recession or slow down, where FII may take out capital and returns from equity market and flee. This may result in chaos in stock markets and ultimately hamper your equity related mutual funds. So, you can stay safe by investing in debt mutual funds, which may fetch lower returns as compared to equity funds (but higher than conventional bank deposits) but may be a lot safer.
Current economic situation and Debt mutual funds
Pause on Rate cut by RBI
In the current scenario where RBI has put a hold on further rate cut in recent announcement of monetary policy, What should you do as a Debt Mutual Fund investor?
How will it impact Debt Mutual Funds?
Well, debt market will not be impacted much and looking at falling interest rates as RBI has already cut 115 basis points starting this year and is expected to reduce further in future, it is suggested to focus on shorter duration funds, corporate bond funds, banking funds, PSU funds. Also, stick to AAA funds.
As RBI consecutively been implementing the Repo rate cut, resulting the interest rate to fall. This has resulted in downward trend in bank deposit rates and any other conventional investment instrument return rate (which is linked to Repo rate). Currently, bank allows interest rate of 6.5-7% interest rate, maximum interest rate on deposits being 7-7.65% for senior citizens. This situation is perfectly ideal for investment in debt funds as it is moderate risk investment alternative but with superior returns as compared to bank deposits.
Global slow down owing to COVID-19
As stated by RBI governor,”Global economic activity has remained fragile; surge in COVID-19 cases has subdued early signs of revival.”
The stock market in recent time has been very volatile. This economic slowdown owing majorly to lockdown amid COVID-19 and volatile stock market is making many investors nervous and confused about their investments.
Foreign Institutional Investors (FII) are the entities which are affected the most by the market trends and economic changes. So whenever, stock market is going through volatile phase, FII will sell out, causing the stock market to come down even further. This will disrupt the equity linked mutual funds, so this is a right time to go for debt mutual funds amid uncertainity, since these funds invest in government securities and other fixed income securities.
Ideally, the current economic situation is better for investing fresh money in debt mutual funds as they fetch better returns than bank FDs and are less risky than equity and equity linked mutual funds. Thus, for short term goals, it is recommended to go for Debt Mutual Funds.
Stay Safe, Stay Invested!
Mutual Funds are the go-to investment instruments for regular investors since these are well suited for financial and tax-saving needs. They are linked to the capital markets and their actions can be regulated by the stock market arrangements. The advantage of mutual funds stems from the fact that the money is diversified. With lower risk mutual Funds are majorly chosen by new investors who are not aware of stock market dynamics and what precautions must be taken to avoid risks.
Investors are risk-averse to mutual fund investments because of the essential risks they would face. Traditional investors trust their money to be safe in fixed-income bearing instruments. However, there are a variety of mutual funds available in the market. Each variety of mutual funds has a different asset distribution which affects the investment risk.
An optimal investment situation can be achieved which means considering different factors such as the investment view, purposes of investment, style of investment, Historical returns trend, fund managers etc. So, to choose the best low-risk fund, you must analyse all these below-given fund types before deciding the best investment option for your financial goals.
1. Large-cap Equity Fund
Large-cap equity fund is those funds which invest in stocks which have a large market capitalization. Large Cap Mutual Funds are usually low-risk investments since they invest in Large Cap Stocks. Those funds are usually also known as blue-chip since they flag more or less stable prices, higher chances of dividends, etc.
2. Balanced Funds
These funds are a combination of debt and equity funds. It gives better parity of funds since the assets are divided into debt and equity. Also known as hybrid funds, these balanced funds carry reasonable risk and yield reasonable returns. Balance funds come with equity exposure which is responsible for high returns whereas debt gives stability.
3. Liquid Funds
Liquid funds are the debt mutual funds in which an investor can expect fixed income. They are called liquid funds because they are short-term maturity investments. Liquid funds are very attractive since they facilitate liquidity and give out higher earnings than bank saving accounts.
4. Arbitrage Funds
These funds are the funds where low-risk investors can get solutions under one roof. The fund leverages the difference in prices in the cash market and the derivatives market to book returns.
5. Gilt Funds
Gilt funds are the funds that invest in bonds or any other fixed-income instruments which are backed by the guarantee of the government. Gilt Funds come with a stable nature of income which is attractive for risk-averse investors.
How to choose the best Mutual Funds with low risk?
We looked at types of mutual funds which help us understand their basic structure and composition of securities in which those invest. Now let’s understand how to select a mutual fund that would be an optimal selection based on multiple factors.
- Comparatively Stable returns
Since these mutual funds invest in government securities, treasury bills, etc., investors can be assured that they stay put in relatively stable instruments. These funds have a lower risk-return ratio.
- Better credit rating
Fund managers at these mutual funds usually incline safe investment alternatives. Since these funds invest in fixed income or fixed maturity instruments, they carry a better credit rating as compared to their other counterparts.
- Comparatively Lower risk
Usually, these mutual funds carry lower risk w.r.t market volatility because these funds invest in instruments that have lower volatility.
Who should go for the Low-Risk Mutual Funds?
- Investors with a lower risk appetite
- Investors looking for moderate but stable returns
- Investors looking for better credit rating
- Investors looking for high liquidity
Best Mutual Funds with low risk in the year 2021
1. Kotak Equity Arbitrage Fund
Kotak Equity Arbitrage Fund is an Arbitrage fund that has a decent fund size of almost Rs.16,360 crores. CRISIL has ranked the fund as above-average wherein the Sharpe Ratio of 1.51 whereas the category average for the same is around 0.74. This would mean that this particular fund is low risk and also has moderate returns even when factored in the risk component.
2. ICICI Prudential Ultra Short term Fund
ICICI Prudential Ultra Short term Fund is a Debt Fund since around 92% of the total fund value is invested in the debt securities. This fund would be an ideal low-risk fund hence is well suited for risk-averse investors. This fund yields comparatively better than conventional bank deposits. This fund has a lower Beta value of 0.07 which shows lower volatility as compared to its peers. One more attractive perimeter is a higher Sharpe Ratio of 4.17 which suggests that it has better risk-adjusted returns.
3. SBI Magnum Gilt Fund
SBI Magnum Gilt Fund is another low-risk fund that is suited best for those who are willing to put in money for longer-term however wish for the safety of the amount invested. This fund invests around 87% in government securities. It is rated 4 stars by Crisil and shows off a better Beta of 0.61 (lower volatility).
4. Axis Liquid Fund
Axis Liquid Fund has 90% dedicated fund allocation in low-risk securities like Commercial Paper, Treasury Bills etc This fund has an expense ratio of0.25% which would result in a better return scenario. Being a liquid Fund, this fund invests in money market instruments that have a maturity period of 91 days or lesser.
5. Canara Robeco Bluechip Fund
Canara Robeco Bluechip Fund, as the name, suggests invests in bluechip stocks and is hence rated 5 stars by Crisil. Asset allocation in equity for this fund is 96% in total. However, almost 75% of funds are allocated to large-cap stocks hence it has a better Sharpe ratio of 0.63 and the highest Jenson’s Alpha of 4.7, which are indicators of better risk-adjusted returns as compared to industry peers.
6. ICICI Prudential Balanced Advantage Fund
This fund is a Hybrid fund which is also known as Balanced Advantage Funds since these invest in stock as well as bonds. ICICI Prudential Balanced Advantage Fund invest around 50% in bluechip stocks and around 28% asset allocation in debt securities. Dynamic investment pattern depends on n market conditions and hence shows up better Treynor’s Ratio of 0.06 meaning better risk-adjusted returns.
Mutual Funds have widened their scopes to match the dynamic markets and have started investing in a multitude of instruments. Once the investor determines their financial goals and assesses their risk appetite, mutual funds prove to be a flexible instrument. Low-risk mutual funds have their pros – stable returns and cons like lower returns. In all, these are better suited to any risk-averse investor who is looking for a safe place to park their funds.