How to choose the best liquid funds for investing in 2023

While investing, there are many things to consider, such as risk, returns potential, long-term growth, and, most importantly, liquidity. That’s right, liquidity! It’s not just the profits you earn but also how quickly you can access it when needed. A well-planned investment portfolio should strike a balance between long-term growth and quick cash access. One simple solution for investors who prefer such a balance is opting for liquid funds.

Liquid funds are debt mutual funds that put your money into short-term securities with maturities of up to 91 days. You don’t have to worry about a lock-in period with liquid funds, and the exit load also does not apply after the 7th day. Thus, these mutual funds make it easy to liquidate your investments whenever needed. The risks are also lower than long duration debt funds or stocks as the maturity period is less, and investments are made into highly liquid money market instruments and debt securities.

Tips to choose the best liquid funds for investing in 2023

  1. Fund size

Assets Under Management (AUM) refers to the total market value of assets managed by a mutual fund at a specific point in time. A larger AUM signifies that the fund enjoys higher participation from investors and  has the resources to make larger investments.

Imagine you have two options: Fund A with an AUM of Rs. 5,000 crores and Fund B with an AUM of Rs. 20,000 crores. Choosing Fund B usually gives you a safety net because a large AUM often implies a more diversified portfolio, better investment inflow, stability, quality, and management experience.

  1. Credit rating: Gauge the risk

Liquid funds invest in short-term debt and money market instruments. These instruments come with credit ratings that range from AAA to D. A higher credit rating, like AAA, indicates that the fund invests in high-quality securities and there is less risk of default. On the other hand, a fund with a mix of lower-rated securities (e.g., BBB or below) may offer slightly higher yields but carries a higher risk of default.

  1. Expense ratio: Lower costs, better returns

The expense ratio measures what a fund house charges to manage your investment. A lower expense ratio often means you get to take a larger portion of the profit. Let’s say you invest Rs. 1 lakh in a mutual fund with a 0.2% expense ratio. Your annual charges would be Rs. 200 (excluding loads and other charges). However, if the expense ratio were 0.5%, you would pay Rs. 500 annually. That’s more than double, which could affect your returns over time.

  1. Past performance: Not foolproof, but useful

Although past returns don’t guarantee future outcomes, they can provide an idea of how the fund has performed during different market conditions. Analyse a liquid fund’s historical returns over different time horizons, such as one year, three years, and five years. Look for consistency and a track record of outperforming its benchmark index.

For example, if a liquid fund has consistently given 7% annual returns over the last three years, it shows stability. In contrast, if another fund offered 9% one year but only 2% the next, it’s a riskier choice given the inconsistency.

Unlocking financial flexibility with liquid mutual funds

Investing in liquid funds can be a great way to diversify your portfolio and earn decent returns on your investments in the short term. The key consideration is to analyse the fund’s past performance, portfolio diversification strategy, expense ratio, fund size to gauge its liquidity and credit quality of the securities. Keep your objectives and risk tolerance in mind to make smart and responsible investment decisions. Above all, consult with a financial advisor. While no one can predict market trends with absolute certainty, good advice can make all the difference.

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