Liquid funds are debt funds that invest in the money market and debt securities like treasury bills, commercial papers, certificates of deposits, etc. These open-ended debt funds have a maturity period of up to 91 days. A liquid fund is the best mutual fund to invest in if you wish to receive a fixed income. Here are the factors to consider when choosing the best liquid fund.
Liquidity of the Fund
Consider a liquid fund's time to redemption. Usually, it's T+1 day, but sometimes, it can be up to T+2 days. Getting short-notice access to funds is beneficial when investing in a liquid fund to park your temporary surplus. Some of the funds come with the facilities of ATM withdrawals and weekend liquidity. Take into account these things when you pick the best liquid fund.
Whether the Fund Outperforms Bank Deposits
The returns of a liquid fund count when it outperforms bank deposits by at least 100-150 basis points. Tax savings offered by these funds compared to bank deposits are an additional benefit.
The Fund's Reaction to Short-Term Rate Spurts
This only happens sometimes. However, remember July 2013 when there was a sudden spurt in short-term call rates by almost 200 basis points in 1 day. If a liquid fund holds on to longer-term debt, the effect of a spurt in returns could be significant. However, the impact may be low for a short-term holding. So, consider the best mutual fund with shorter-tenure debt in its portfolio.
Exit Load of the Fund
Exit load is not charged on a very short-term liquid fund. However, other categories of liquid funds, like ultra short-term and liquid-plus funds, charge an exit load. So, see if it's being charged. A zero exit-load liquid fund is a good option, mainly for a systematic transfer plan.
Diversification of the Fund
Although there are limitations on a debt fund's exposure to a single business unit or group, a liquid fund can thematically have major exposure to a specific group or sector. Nevertheless, it's better to have a diversified portfolio. The best liquid fund should be diversified across themes, sectors, credit profiles and maturities. This will help in the fund's risk management.
Deviation of the Returns from the Mean
If you aim at better returns by taking a higher risk, it's a good idea to consider a G-Sec fund or a debt fund in which returns go up with the level of risk. Usually, with negligible risk, a liquid fund earns more than a bank deposit. A deviation in returns implies a change in risk. So, consider this factor when choosing the best liquid mutual fund.
Conclusion
If you have idle cash to invest for the short term to enjoy better returns than a typical savings account, opt for a suitable liquid fund after considering the above factors.