The role of duration in liquid fund performance

Investors often navigate the complex world of mutual funds in pursuit of optimal returns while managing their risk appetite. Among the various categories of debt funds, which include overnight funds, liquid mutual funds, low-duration funds, and medium-duration funds, the choice of investment horizon plays a pivotal role in determining the potential returns. This article shall elaborate on the features of liquid mutual funds and explore how their duration impacts their performance, helping investors make informed decisions while investing in them.

Understanding liquid mutual funds

Liquid mutual funds, a category of debt funds, primarily invest in fixed-income instruments such as commercial paper, government securities, treasury bills, and certificates of deposit. These funds offer high liquidity, making them an attractive option for investors seeking both safety and accessibility. Investors also use their liquid mutual fund investments to build an emergency; since these mutual funds offer quick access to cash when needed. Read more about the five key features of liquid funds here:

  • Liquid mutual funds are not very volatile.

A liquid fund has a maturity of up to 91 days, hence, investors need not worry about their volatility. This feature offers a considerable advantage to risk-averse investors. The short maturity period ensures that the fund’s NAV (Net Asset Value) remains relatively stable, making liquid mutual funds an ideal parking spot for surplus cash that might be required on short notice.

  • Attractive returns on average through liquid fund investments.

While these returns may not match the potential gains of equity mutual funds, they certainly outperform traditional savings accounts by a significant margin. This makes liquid funds an attractive option for investors who want to earn more on their idle cash without taking on excessive risk.

  • Liquid funds have a short investment horizon.

Investors who wish to park their income for a duration of 1 day to 3 months can invest in liquid mutual funds. Investors often use liquid funds as a temporary repository for funds earmarked for upcoming expenses or investment opportunities. This short investment horizon aligns perfectly with the fund’s short-term asset portfolio.

  • Liquid mutual funds charge an expense ratio.

Liquid funds typically have a lower expense ratio compared to other debt fund categories, which contributes to their overall appeal. However, investors should still carefully evaluate these costs to understand their impact on returns.

  • Liquid funds offer reasonable returns at lower risks.

Investors can redeem their liquid fund units at any time, and the funds are credited to their bank accounts within 1-2 working days. This liquidity feature makes them comparable to the ease of access provided by a traditional savings account while potentially offering better returns.

The role of duration in the performance of a liquid fund

Liquid funds strike a balance between safety and returns, making them a versatile tool for individuals seeking to maximize their earnings while maintaining liquidity. If an investor wishes to allocate a considerable income for a short duration with lower risks, liquid funds emerge as an ideal choice. These funds offer a middle ground between the negligible returns of a savings account and the higher but more volatile returns of equity funds. While liquid funds may not be the best choice for long-term wealth creation, they provide a balance between safety and returns for shorter investment horizons.