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Three reasons to ditch that FD and link a liquid fund

by Money Puzzle   ·  April 8, 2019   ·  

Three reasons to ditch that FD and link a liquid fund

by Money Puzzle   ·  April 8, 2019   ·  

Why do you buy a fixed deposit? The answers probably are as simple as, to keep my savings safe, to invest what I save and so on. How much thought does one really give to the returns you earn through a fixed deposit investment? Here are three quick point to ponder on:

  1. A one-year fixed deposit in SBI will earn you 6.8% per annum, this can go up to around 7.5% with some private banks and even 8% in some cases.
  2. Your return net of tax if you are in the highest tax bracket of 30% is between 3.5-4.1% per annum and at the lowest tax rate it is 6.4% to 7.6%.
  3. FD’s are locked in products and don’t have the flexibility of redeeming at a moment’s notice.

But what is the alternative? Corporates, large and small, have been partly investing their surplus cash in a type of mutual fund scheme called liquid funds for many years. These are extremely low risk schemes and come with the flexibility of withdrawing at a day’s notice. Bulk of the liquid funds today are giving anywhere between 7%-7.5% return – net of tax this is at the higher end of your FD return range.

These are extremely low risk schemes and come with the flexibility of withdrawing at a day’s notice.

Here is what you need to look out for while investing in a liquid fund:

  1. Ensure that the minimum investment amount is low so that it suits your monthly savings.
  2. Keep a watch on the annual expense ratio of the scheme – ideally this should not be higher than 0.2-0.25%
  3. Pick a fund with an average portfolio quality of AAA – which indicates that most of the securities held are of the highest degree of safety or lowest default risk
  4. Portfolio average maturity or in other words the maturity remaining on the securities held should not be more than 60 days.
  5. Lastly, ensure that the portfolio is not over allocated to any one security – 3-4% maximum allocation to one security is reasonable, anything more than that is a red flag.

This may all sound a little technical, but all these parameters are easily verifiable in the fund fact sheet available on the asset manager’s website. If you are using an online portal to invest, even there you should be able to check these details or you can simply check the name of the fund and go to the asset management company’s website to check details.

Opting for liquid funds will keep your investments safe, accessible at any time and help you maximise the return expected for short period of time.

Why does the price or net asset value (NAV) of a liquid fund fluctuate?

If you are investing in what is considered a low risk or relatively safe investment, you don’t want to see its value move up and down too much or at all! Hence, you may not be happy to know that the NAV of your liquid fund can indeed move down sometimes.

Here is why. First let’s understand what is in this liquid fund. Think of any fund as basket of securities. In the liquid basket, there will be debt securities like corporate commercial papers, government bonds and treasury bills, bank certificate of deposits and even fixed deposits. Most of these will be due for maturity within two months.

There are two ways in which the fund price changes on a daily basis. Firstly, for securities which have a maturity of less than 30 days, the interest accumulated on a daily basis is added to the price. Secondly, for the other securities it’s the change in estimated market price which is added. Now This estimated market price can be impacted by daily shifts in interest rates. If interest rates go up, prices come down. However, given that the time to maturity for the securities is still very less ie. less than 60 days the change will be very small. Nevertheless, the presence of securities with a maturity above 30 days can cause a shift in daily NAV.

It is, however, unlikely to impact your return meaningfully. The rolling 3 month for the top 10 (by assets under management) schemes in the category has been around 7% annualised and the volatility in returns as measured by annual standard deviation is a low 0.17%.

Daily fluctuation in NAV thus going to be fairly minimal. Keep the checks in place and then pick a liquid fund that keeps your money healthy and flexible.

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