Is Investing in Long-Term Liquid Mutual Funds Worthwhile? A Comprehensive Analysis
Liquid Mutual Funds are ideal for investors seeking to park their short-term surplus. But can they be a viable long-term investment option, particularly over a 3-year period? Let's explore the benefits and returns of these funds, as well as compare them to bank fixed deposits (FDs).Definition and Suitability
By definition, liquid mutual funds invest in debt instruments with a maturity of up to 91 days. In common parlance, these funds do not cater to long-term lending. Instead, they are best suited for short-term parking needs, aligning well with the maturity profile of the funds and the investor’s short-term financial requirements.
Flexibility and Utility
One of the key utilities of liquid funds is their flexibility in uncertain situations. For example, if you are planning to buy a flat that is fully built and ready to move in, you may need to make a downpayment to the builder and enable the bank to pay the balance. During such times, liquid funds provide a perfect solution. The fund can be used to park your surplus, enabling you to make the downpayment as needed without having to commit to a long-term investment with a predefined maturity.
Comparing Liquid Funds and Bank FDs
Liquid funds can provide you with a higher return compared to a savings account. They also offer more flexibility, as they do not have a predefined maturity period. For instance, in bank FDs, if you close your fixed deposit prematurely, you might redeem at a lower interest rate or even face penalties. Liquid funds, on the other hand, provide a pro rata return, so you get the exact return you expect based on the duration you hold the investment.
Moreover, certain liquid funds offer redemption facilities through the Immediate Payment Service (IMPS), allowing you to access your emergency corpus at any time. While bank FDs are typically available for 91 days, 180 days, 270 days, or one year, liquid funds can be accessed early without penalties. Additionally, if you hold liquid funds for more than 3 years, you can enjoy the benefit of indexation, which is not available with bank FDs.
Performance and Indexation Benefit
Over a 3-year period, select liquid funds have consistently offered good returns. For example, HDFC Liquid and Franklin India Liquid have CAGR returns of 6.9% and 7.1%, respectively. In comparison, the 1-year SBI FD rates have hovered around 6.50-7.00, suggesting that liquid funds could provide similar returns.
The returns from liquid funds are classified as capital gains, and since you have stayed invested for 3 years, you qualify for indexation benefits. This means that the gain is adjusted for inflation, potentially lowering your tax burden. For instance, if you invested Rs. 100 for 3 years earning 7%, the amount at the end of 3 years is Rs. 121. Under indexation, you would add inflation (let's assume it at 4%) to your cost, making your indexed cost Rs. 112. The tax payable on the indexed gain of Rs. 8 (121 - 112) at a special tax rate of 20% would be Rs. 1.60, a significant reduction from the Rs. 6.30 tax you would have to pay on non-indexed gains.
Conclusion
Liquid mutual funds can be a versatile investment destination for those seeking to park their surplus in a flexible and potentially high-return manner. While they may not be suitable for long-term, high-risk investments, they can provide a solid base for short-term to medium-term financial planning. The flexibility and tax benefits make them particularly appealing, especially when compared to fixed deposits.
Happy investing.