How safe are Liquid Funds?

High liquidity, low cost, minimal risk, stability as well as quick redemption. If this is what you desire from your mutual fund investments, then liquid funds are where your money needs to go. These funds invest their corpus in various debt and money market instruments with a maturity period of a maximum of 91 days.

Key features of Liquid Funds

• These funds have low-cost structures. Generally, the expense ratio for liquid funds stays below even 1%.

• Investors are not bound by any lock-in period.

• They do not have any exit load if redemption is done after seven days of investing.

• Redemption requests for these funds are processed within one business day. Some schemes also offer the facility of instant redemption.

In comparison to the other debt funds, liquid fund investments offer more stable returns. This is due to the fact that prices of short-term securities are not as prone to volatility as long-term bonds.

Risks in Liquid Funds

Liquid fund investments are considered as one of the safest. They predominantly invest in high quality and government-backed debt instruments and hence the chances of default are almost minimal. Additionally, the maturity period of these instruments is not more than 91 days. Hence, they do not witness too much volatility.

So, is there zero risk in Liquid Funds?

Are liquid funds completely risk-free? The answer is no. None of the investment avenues can be completely devoid of any risk. Though the risk in liquid funds is minimal (especially when compared to equity schemes) that there is some risk even with these funds. We will analyze how safe or vulnerable are these funds from the perspective of three critical risk-inducing factors

• Interest Rate Risk

Liquid Funds are a type of debt funds that invest their corpus in bonds, debentures and other such instruments. There exists an inverse relationship between interest rate movements and bond prices. Hence, if the interest rates go up there will be a fall in the bond prices.

However, the interest rate risk in liquid funds is almost negligible. This is because the maturity period of the liquid fund investments is very short. The quotient of risk in liquid funds increases or is considered significant when the duration of the underlying debt instrument is longer.

• Credit Risk

This refers to the risk that the issuer of the bond (or the borrower) is not able to pay the promised interest to investors. Mutual Funds (especially debt funds) always have some degree of credit risk. In the case of liquid funds, if the credit rating of any underlying instrument or security goes down, the NAV of the fund will also witness a drop.

• Inflation

This is one factor that is applicable at a macro-economic level. It applies to all investment avenues and is not specific only to liquid funds. When the cost of things goes up, RBI tries to control the flow of money in the economy. It hikes up the interest rate so that credit becomes expensive. As interest rates and bond prices are inversely related, this hike will cause the bond value to go down. This, in turn, will negatively impact the NAV of the fund.

Final Words

So, is Liquid Fund investment a good choice in spite of these risks? 100% per cent yes. These funds are perfect for investors who are looking for a lucrative option to park their surplus cash or unexpected income, before deciding the long-term course of action. Liquid Funds are also a perfect route to finance your short-term goals such as a vacation, purchase of household goods, etc. or even an emergency fund. Through the STP (Systematic Transfer Plan) functionality, you can even transfer the proceeds from liquid funds to other mutual fund schemes as and when required.