5 Ways In Which Liquid Funds Changed Recently In 2022
Traditionally, a liquid fund would invest in fixed income securities, which will result in the creation of a portfolio that contains a variety of debt and money market products. Some common products that are traded on the money market are commercial paper, bank deposits, and treasury bills. These are short-term instruments, and the liquid fund only invests in assets that seem to have a maturity duration of up to 91 days in the future. Here’s how liquid funds have changed recently –
1. RBI price cut
The Reserve Bank of India (RBI) would boost the economy by reducing the repo as well as reverse repo rates on occasion. This became particularly necessary in light of the economic slump that followed the outbreak and the subsequent lockdown that occurred as a consequence of the virus. The Repo Rate was lowered by 40 basis points (bps) in May 2020 by the RBI. Within the span of a single year, this resulted in a reduction in the Repo Rate from 6% to 4%. A combination of factors, including the reduction in policy rates by the RBI and sufficient liquidity within the financial system, has resulted in a precipitous decline in short-term interest rates and an effectively slower rate of growth for liquid assets.
2. Threat of Inflation
Returns on liquid funds are often lower than those on riskier assets such as stocks and bonds because of the stability and short-term nature of the investments that they are backed by. In turn, this raises the possibility that the rate of interest will not keep up with the rate of inflation. The risk of inflation is the possibility that an increase in general price levels may have the effect of reducing the buying power of a bond’s fixed interest charges.
The higher the duration of a bond’s maturity, the greater the danger that it may experience inflation. Bond rates frequently factor in forecasts of inflation, allowing investors to get compensation for the possibility of future price increases.
3. Brand new budget
When these factors are taken into account, the most risk-free option among debt funds continues to be liquid mutual funds. Given that the interest rates on savings accounts at banks have also been drifting lower (SBI: 2.75 percent) for much the same reasons as liquid funds, it continues to produce returns that are equivalent to those of your savings bank account.
You can also find liquid funds as just a component of short-term portfolios, including the Short Term Money Plan offered by Scripbox, along with Ultrashort, as well as low Duration Funds. Such types of portfolios prioritize the safety of their investors’ capital while providing returns that are superior to those offered by FDs over a time duration of 1 year to five years.
The Reserve Bank of India (RBI) makes choices on interest rates, and bank fixed deposits (FDs) are subject to the same judgments that liquid fund investments are, which results in a similar pattern of diminishing returns. However, taking into consideration the liquidity as well as post-tax benefits, integrated low duration funds as well as liquid fund portfolios, including the Short Term Money plan, remain to be a superior option to FDs.
4. High volatility
The Fund will construct a portfolio consisting of debt and marketable securities that have a duration of one to three years at most. When opposed to long-term bonds, short-term debt instruments are much less sensitive to shifts in interest rates due to their shorter maturities. Therefore, because of the information about the underlying instruments, the fund does have the potential to generate returns that are consistent with their value.
5. STP option
Also perfect for systematic transfer into equity funds are liquid funds. Since investing in equity funds requires accurate market timing, it is not a good idea to put all of your money into one fund at once. STP is used by average investors as a means of avoiding lump-sum investments.
During an STP, a predetermined sum of money is moved from a liquid fund to an equity fund. You might be able to accomplish cost-averaging if you do it this way. You also receive increased returns on the balance of your liquid funds.
Liquid funds have become a much more sensible option for investors in recent times due to these reasons.