What are the Advantages and Disadvantages of Liquid Funds

Disadvantages of Liquid Funds

Liquid funds are one of the many types of mutual funds available in the market. They invest in short‐term assets such as treasury bills, government securities, repos, certificates of deposit, or commercial paper. They are debt funds which enable companies to raise money for a Period of up to 91 days. These are highly secured and short term funds usually suitable for putting money aside for emergencies as there is almost zero risk involved with such securities. 

Advantages of Liquid Funds

Liquid funds are perfect for financial specialists who need to park their money for a short period of time. The aim of these liquid mutual funds is to provide higher returns while offering a similar level of security for the money invested. Here are some of the advantages of Liquid Funds :-

  • Low Risk: Liquid funds invest only in highly secured government funds. So the associated risk is minimal. Along with this they are known to provide stable returns to its investors in the form of interest as they are debt instruments.  
  • High liquidity: Liquid funds are short term funds with short redemption periods and low chances of defaults in payments. The redemption cycle is generally of one day or less. Hence, such funds provide high liquidity.
  • Quick Redemption: The investor has a flexibility of holding onto the securities till he wants before the maturity, which means that he can exit the investment as and when he deems fit. However, if he exits the scheme within 7 days, a small exit load is charged for redemption of his investment.
  • Low cost: The expense ratio associated with such securities is generally below 1%.This low‐cost structure allows them to maximize the effective return to the investor.
  • Higher Returns During inflationary Markets: Liquid funds are also suitable for times of inflation. In such economic situations of high inflation, RBI offers a high-interest rate to control the overall market liquidity. This helps to gain good returns on the liquid funds.

Disadvantage of Liquid Funds

The advantages discussed, now it’s time to focus on the disadvantages of Liquid Funds.

  • Exit load : Although there is no lock-in period, a small financial charge known as exit load is applicable if the user exits the investment within a specified period. This is a charge applicable where the investor exits the schemes within 7 days. However, it shall be noted that such charges are often very low.
  • Low returns : The prime disadvantage of investing into a liquid fund is that they provide a comparatively low rate of returns as compared to high return investment options. So, if you invest in liquid funds you forego the high returns which high-return funds may provide you.

Are liquid funds suitable for you?

Liquid funds are highly-secured debt instruments which provide flexibility in terms of exit option and quick redemption of investment. Along with this it provides the investor a stable income. Such income is generally low as compared to other securities. However, such returns are risk free with almost no chances of defaults. Therefore, we could conclude that if you are an investor with low risk appetite or want to generate a stable income for a short period you can opt or liquid funds. Such funds can also be opted when the market is unstable or in times of inflation.