Liquid Fund an alternative to Bank FD

Liquid Funds and Ultra Short Term Funds are debt mutual fund schemes investing in safe money market instruments and are better than Bank Fixed Deposits(FDs). They provide tax-free returns!! Liquid Funds are very safe debt instruments sold by mutual fund companies.

Liquid Funds are for the rich people while Bank Fixed Deposits are for the general public.

Liquid Funds à  No entry load, no exit load, no brokerage charge, no tax, you can sell even next day, invests in instruments having maturity of less than 90 days.

Mutual fund company pays 25% dividend distribution tax then the remaining comes into your pocket. The returns shown are post tax returns. You don’t pay any tax at your end (like you pay on Fixed Deposits). You can buy and hold the fund for many years without any problem. You can call your stock broker and buy these mutual funds.

Ultra Short Term Funds (also called Liquid Plus Funds) -à No entry load, may have 0.25% exit load if sold before 2 months(few schemes don’t have it), no brokerage charge, no tax, you can sell even next day, invests in instruments having maturity of more than 90 days.

Mutual fund company pays 12.5% dividend distribution tax then the remaining comes into your pocket. The returns shown are post tax returns. You don’t pay any tax at your end (like you pay on Fixed Deposits). You can buy and hold the fund for many years without any problem. You can call your stock broker and buy these mutual funds.

Liquid Funds/Ultra Short Term Funds invest in Govt Bonds, CD(Certificate of Deposits), CP(Commercial Papers), Reverse REPO, NCDs(non convertible debentures). They are extremely safe!  But the Mutual Fund company doesn’t guarantee any interest payment(though it pays interest every day since 2003). CDs have high liquidity while CPs have low liquidity, hence CDs are preferred.

Liquid Funds pay interest even on Saturdays and Sundays. You receive interest till the Liquid Fund is in your demat account.

For equities, more the investment holding period, more the safety. In debt markets, more the investment holding period, higher is the risk. So Liquid Funds have very low risk while Ultra Short Term Funds have low risk. Till now no Liquid Fund has ever defaulted.

To avoid risk, invest in 5 Liquid Fund schemes instead of a single Liquid Fund. If the corpus is more, invest in 15 Liquid Funds(diversification). Divide your investment into different Mutual Fund Companies to reduce risk.

Ultra Short Term fund is better than Liquid Fund if it does not have an exit load.

Factors to consider before choosing a Liquid Fund:

1)      Size of fund should be greater than Rs.1000 crores ideally. Minimum Rs.500 crores +

2)      There should not be any entry load, exit load, brokerage charges.

3)      Opt for daily dividend. There is no tax on dividends(at your end) but there is tax on growth option(tax  is paid at your end). Mutual Funds pay dividend distribution tax(internally) and the returns you receive are tax free returns.

4)      Payout (while exiting) should be on same day and not after 3 days(ideally).

5)      Fund scheme should be atleast 3 years old.

6)      No single investment done by the fund should be greater than 10% of its size. i.e. if the fund holds CDs of banks then ensure that it doesn’t hold any SINGLE CD investment(of any SINGLE bank) which is greater than 10% of the fund’s total size.

7)      Check the minimum investment required. For daily dividend, the minimum investment in most funds is HIGHER i.e. Rs.1 lakh. In such a case (for lower minimum initial investment) opt for weekly dividend or monthly dividend and growth option as the last resort (as you will have to pay tax on growth option).

8)      Check whether the payout (after exit) is via cheque or directly into bank account.

9)      Regular Option is for small retail investors. Institutional and Super Institutional option is for Big investors (minimum Rs.1 crore + investment).

10)   Check expense ratio of the fund (charged by AMC).