Wednesday, 5 February 2014

Mutual Funds: A Case For Liquid Funds

Liquid funds are a type of mutual funds that invest in securities with a residual maturity of up to 91 days.

i.e., ultra ultra short term funds.

And for this reason, Liquid funds have low interest rate sensitivity.

Interest rate sensitivity is a serious issue, because reserve banks the world over, keep changing interest rates, for one reason or another.

If you understand macroeconomics well enough to take advantage of interest rate fluctuations, go for short, medium or long term debt funds.

But it's not easy to guess what a reserve bank will do next with the interest rates. Not even for the experts. The recent interest rate hike by the Indian Reserve Bank, was a surprise, even for the experts. (It's the same every time.)

So, owing to their negligible interest rate sensitivity, Liquid Funds are very stable, very safe, and generally progress smoothly. No risk, if the company offering the Liquid Fund is good. Enter anytime. Exit anytime.

A typical Liquid Fund, from Economic Times: Morgan Stanley Liquid Fund.

A typical NON LIQUID debt fund looks like this...a roller coaster ride. That could go on longer than your patience...

Source:Economic Times: Morgan Stanley GILT

Another good thing about Liquid Funds is the low tax, if kept for more than 365 days. Their tax calculation is done using INDEXATION, which takes into account inflation. The sample tax calculation at this link applies to India, but I won't be surprised if taxes on Liquid Funds are comparable, in most parts of the world.


I really don't like strategies, they fail mostly, and create accounting nightmares...I believe in simplicity, but here is a strategy that is interesting.

This strategy applies to Liquid Fund investments that are less than 1 year, i.e. capital gain is added to income. By employing this, taxable capital gain (not actual gain) reduces, because dividends are tax free.

Quote, "ValueReasearchOnline:
"Consider opting for dividend reinvestment when investing in a liquid fund because dividends stripped will be reinvested as units and will be considered as fresh investments. This way the capital gain will be very low."

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