Cash management has been an issue for most of us, especially in the short term. If a person has surplus cash for a short span of time like a week or a fortnight, how can he make the most of it? Banks offer limited options. A fixed deposit would be attractive only in the longer term. Savings and current accounts do not offer good returns. Investing in shares for such a short term drives up the transaction costs.
Liquid Funds are good alternatives in such scenarios.
What exactly are liquid funds and how do they operate? They seek to offer optimal returns with moderate levels of risk and high liquidity. A liquid fund usually invests in short term debt instruments which carry lower market risk.
In fact, they can invest only up to 10% of their net assets in instruments which are marked to market (instruments whose prices vary with change in market conditions) thus reducing the risk of depletion in capital.
In short, they are relatively safer instruments with lower credit risk. For instance, the Quantum Liquid Fund invests a minimum of 80% of its net assets in AAA rated companies or equivalents (The rating implies the highest safety of timely payment of interest and principal).
Liquid Funds offer high liquidity. A person can park his money for a short term like a week or even a few days. Under ideal working conditions, his investment can be redeemed on a T+1# basis. Contrasting most other mutual fund schemes, liquid funds do not levy any charges for investments or redemptions. Unlike fixed deposits, there are no pre-withdrawal penalties.
The only charge would be an expense ratio which covers the investment management and other costs. This is also on the lower side - for the Quantum Liquid Fund, the estimated annual expense ratio is 0.45%.
Another advantage is from the tax perspective -- dividends received are tax free in the hands of investor. The fund pays a dividend distribution tax of 22.44% for a corporate investor and 14.02% for an individual, both of which are lower than the highest marginal income tax rates. A typical comparison between liquid funds, bank savings accounts and fixed deposit can be depicted as follows. # T+1 means Day of Trade + 1 business day.
Table 1: Advantage Liquid Funds
|
|
|
Savings Deposits |
Fixed Deposits |
Liquid Funds - Dividend Plan |
|
Notional Amount (Rs. 3 month investments |
100,000 |
|
|
|
|
Assumed Annualized Interest Rate/Yield |
|
3.50% |
6.50% |
6.50% |
|
Net Income Post Expense |
|
875 |
1,625.00 |
1,625.00 |
|
Income Tax on Deposits * |
30.60% |
267.75 |
497.25 |
- |
|
Dividend Distribution Tax + |
14.03% |
- |
- |
227.91 |
|
Post Tax Return |
|
607.25 |
1,127.75 |
1,397.09 |
|
Annualized Net Post Tax Retur |
|
2.43% |
4.51% |
5.59% |
|
( * - Assumed at the highest tax slab, + - Dividend Distribution Tax paid by the fund) | ||||
The author is associate fund manager, Quantum Liquid Fund. He can be contacted at Arvind@QuantumAMC.com
Disclaimer: Investment in mutual funds are subject to market risks including uncertainty of dividend distribution and the NAV of the scheme may go up or down depending upon the factors and forces affecting the securities markets. Please read the offer document of any scheme/s before making any investments.