Liquid funds are best for those who are looking for short-term investment avenues. Instead of keeping it in a savings bank account, you can invest that recent bonus which you received in a liquid fund. In this case, you want to know the parameters of choosing the best liquid mutual fund. Also understand if there are limitations of the scheme.
Parameters to help choose the best liquid fund:
- Returns & Fund house checks: Past Performance of the fund and the track record of the AMC has to be checked. The long term track record of the AMC need to be given attention. Choose a fund house with a consistent fund history/performance/return record for the last 5 to 10 year.
- Securities details: It will be good to know the portfolio break-up in terms of the type of securities. The ratio of CBLOs, commercial papers, treasury bills, certificate of deposits, bonds with residual maturity of less than 91 days. This shows the true liquidity of the liquid portfolios.
- Credit Rating: Highest rating is AAA. Higher credit rating denotes less chances of default, hence less risky.
- Portfolio Allocation: Liquid funds have nearly zero marked-to-market component hence credibility of the issuers in the portfolio has to be looked at.Scheme’s portfolio and instruments in which allocation has been done has to be checked.
- Average Maturity: Liquid funds invest in instruments which mature within 91 days. Lower average maturity indicates that the fund is holding more cash, which in turn gives less return on capital gains.
- Objective of the fund: There are different plans like growth plans, daily dividend plan, weekly dividend plans and monthly dividend plans. Plans have to be chosen based on your risk appetite & fund requirement.
- Costs: Liquid funds charge a fee to manage your money called an expense ratio. Analyse least expense ratio with consistent fund returns.
Limitations of Liquid Mutual Funds
Costs: Some mutual funds have a high cost associated with them. Depending on the fund, the expense ration can be significant. Different funds have different expense ratios and need to be checked.
Dilution: Diversification has an averaging effect on your investments. While it saves you from suffering any major losses, it also prevents you from making any big gains! Therefore, major gains get diluted. That is why it is recommended that you do not invest in too many mutual funds.
Any financial decision has to be an informed one, where all the details need to be read and understood. Mutual funds are subject to your risk appetite and financial goals. Liquid funds pose as a good investment for those who have idle cash for a short time span.