What are Liquid Funds? How are They Taxed?

When it comes to investing your idle cash and earning some returns, Liquid Funds and Liquid ETFs, also known as Liquid Exchange Traded Funds, are two popular options. These investments are known for their liquidity and safety. Let us explore the comparison between Liquid Funds and Liquid ETFs, making it easy for you to align better with your financial goals and preferences.

Understanding Liquid Funds 

Liquid Funds are a type of MF that primarily invest in Short-term Debt Securities with up to 91 days maturity. They are known for their liquidity, safety and ease of investment. Liquid Funds allow investors to earn returns on their surplus cash without compromising accessibility.

Key Features of Liquid Funds:

• High Liquidity: You can redeem your Liquid Fund units quickly, within 1-2 business days

• Safety: Liquid Funds typically invest in highly rated debt instruments, minimising credit risk

• Low Minimum Investment: You can start with a relatively small amount, making them accessible to all investors

• Stable Returns: While returns may vary, Liquid Funds aim to provide stable, although modest returns.

Understanding Liquid ETFs

Liquid ETFs are similar to Liquid Funds invest in Short-term Debt Instruments. However, they are traded on Stock Exchanges like regular Stocks, providing a different level of accessibility and flexibility.

Key Features of Liquid ETFs:

• Market-Traded: Liquid ETFs are bought and sold on Stock Exchanges during trading hours, allowing for real-time transactions.

• Transparency: ETFs provide full transparency of their holdings throughout the trading day

• Low Expense Ratio: ETFs generally have lower expense ratios compared to traditional MFs

• Liquidity: Due to their exchange-traded nature, you can buy or sell Liquid ETF units at prevailing market prices during trading hours.

Comparing Liquid Funds and Liquid ETFs

Now, let's compare Liquid Funds and Liquid ETFs on various parameters, to help you make an informed decision.

Liquidity

• Liquid Funds: Offer high liquidity, but redemptions typically occur at the Net Asset Value (NAV) of the next business day

• Liquid ETFs: Provide intraday liquidity, allowing you to buy or sell units at prevailing market prices during trading hours.

Transaction Costs:

• Liquid Funds: Generally do not have brokerage costs, but some may charge an exit load if redeemed within a specified period

• Liquid ETFs: Incur brokerage charges when buying or selling, similar to Stocks.

Expense Ratio:

• Liquid Funds: Have a marginally higher expense ratio compared to Liquid ETFs

• Liquid ETFs: Tend to have lower expense ratios, contributing to cost efficiency.

Taxation:

• Liquid Funds: Taxed as per your Income Tax slab, if held for less than three years. After three years, they qualify for Long-Term Capital Gains (LTCG) Tax with indexation benefits

• Liquid ETFs: Taxed similarly to Stocks. Holding for less than a year attracts Short-Term Capital Gains (STCG) Tax and holding for more than one year leads to Long-Term Capital Gains (LTCG) Tax.

Accessibility:

• Liquid Funds: Can be invested in, through various platforms including MF Houses, Banks and Online Investment platforms

• Liquid ETFs: Require a Demat Account for trading, which adds an extra layer of complexity.

Customisation:

• Liquid Funds: Offer multiple options catering to different risk appetites and investment horizons

• Liquid ETFs: Limited to the available ETF options in the market.

Suitability:

• Liquid Funds: Ideal for investors seeking safety, liquidity and ease of investment for their short-term funds

• Liquid ETFs: More suitable for those comfortable with Stock market transactions and looking for intraday liquidity.

Unlocking Opportunities with Liquid ETFs

For traders and direct equity investors, idle cash sitting in their Fund Account with their broker can be a common scenario. You keep that balance as a reserve, waiting for the right investment opportunity, without the hassle of withdrawing and adding funds repeatedly. But, your idle cash is not earning any returns during this waiting period. That's where Liquid ETFs step in, offering a solution to make your money work for you, even while on standby.

• Earning Returns on Idle Cash: Liquid ETFs provide an avenue to invest your idle cash effectively. You can allocate the amount lying dormant in your Broking or Trading Account into Liquid ETFs and start earning returns on it. This ensures that your money doesn't remain stagnant and can grow while you await the next investment opportunity

• Flexibility to Seize Opportunities: One of the key advantages of Liquid ETFs is their flexibility. As soon as you identify a promising investment opportunity, you can easily liquidate your ETF holdings and deploy the capital into your desired Stocks or Assets. This seamless transition allows you to capitalise on market movements, without missing out on potential gains

• Pledge for Margin Money: Liquid ETFs offer an additional benefit to traders. In derivatives trading, having sufficient margin money in your Account is essential. Here's where Liquid ETFs come into play again. You can pledge your Liquid ETF holdings to secure Margin Money for trading. After a 10% cut, you can utilise up to 90% of your Liquid ETF's value as Margin Money. The significant aspect is that, even 90% of the pledged Liquid ETFs continue to earn returns, making your money work doubly hard.

Choosing between Liquid Funds and Liquid ETFs depend on your investment preferences and requirements. Liquid Funds may be the better choice if you prioritise high liquidity and ease of investment. On the other hand, if you seek intraday liquidity, real-time pricing and lower expenses, Liquid ETFs could be more appealing. When deciding, consider your financial goals, risk tolerance and comfort with trading platforms. Ultimately, both options offer a secure place to park idle cash while earning returns.