whats the difference between liquid fund and debt/FMP fund

FMP is a fixed maturity plan of a mutual fund into which you lock your funds. The liquid funds are those mutual funds where from you can withdraw money on short notice of a day or two. The return on FMP is better.

HELLOW  ALL,

PLEASE SAID ME WHAT IS THE DIFFERENCE BETWEEN CASH MUTUAL FUND AND LIQUID FUND?

 

THANKS

SHITAL

All of us want our money to grow but not many of us give much thought to taxes while making investments. The fact that millions in our country still rely on traditional instruments like bank deposits and small savings schemes to invest their money testifies this point. These instruments not only give low returns but also are fully taxable. Clearly, the main attraction is the “safety” provided by these instruments. Though, it is quite natural to be concerned about the safety of one’s hard earned money, by giving too much importance to this aspect we do not allow our savings to grow at a meaningful rate. While tax efficiency alone should not drive the investment strategy, it can make a substantial difference to your portfolio’s ultimate size. In other words, tax efficiency has to be an essential element of any investment plan along with portfolio mix, investment philosophy and management. While paying taxes when necessary is understandable, paying more taxes than necessary is not! The ultimate objective of investing should be to fund your current and future requirements by maximizing your returns in a manner consistent with your means, future needs and risk tolerance. The tax efficiency becomes even more important when one intends to invest in safer instruments offering predictable returns. Mutual funds, as an investment vehicle, are one of the most tax efficient ones. Besides, they offer variety of products in this category to suit the needs of investors depending on their time horizon like liquid, floating rate, short and medium term debt funds, Fixed Maturity Plans and arbitrage funds. Let us understand as to what each one of these offers and how tax efficient they are: Liquid Funds Liquid funds seek to maximize current income commensurate with low levels of risk and high liquidity. These funds primarily invest in low duration and liquid investments like money market as well as debt instruments. Liquid funds are ideal for investors looking to park their short term funds yielding higher post tax returns compared to banks and well as for those looking for current income and preservation of capital. These funds, however, in the recent times have lost their sheen due to higher dividend distribution tax compared to other category of debt funds. Liquid funds currently pay a dividend distribution tax of 28.33% for all categories of investors as compared to 14.16% for individual investors and 22.66% for corporate investors in other debt funds. Another variant of liquid funds is Liquid Plus funds. These funds are positioned between short term debt funds and liquid funds and are more tax efficient compared to liquid funds. Floating Rate Funds Floating rate funds invest in instruments whose interest rate changes as per the market condition. Simply put, in a floating rate instrument, the coupon rate is not fixed. Instead, it is benchmarked against a market driven rate like Mumbai Interbank Offered Rate (MIBOR). As the coupon rate is adjusted to the benchmark rate, the NAVs of these funds do not react much to the changes in the interest rate environment. Floating rate funds can also be good options in a scenario where the interest rates are expected to rise. Besides, they are more tax efficient than liquid funds. Floating rate funds are ideal for investors looking to park short term funds and that too without any risk of losing capital due to interest rate volatility. Short and Medium term debt funds Short as well as Medium term debt funds aim to generate income and capital appreciation through a portfolio of debt as well as money market instruments. Short term debt funds however are less volatile compared to medium term debt funds as they have relatively lower average maturity of the portfolio. Besides, short term debt funds have a favourable risk return profile as they have lower standard deviation compared to medium term debt funds. These funds are appropriate for investors who have short term investment horizon and look for an option that is less volatile but has the potential to perform better than liquid or floating rate funds. Medium term debt funds or Income funds, as they are popularly known, invest in corporate and sovereign debt with maturities ranging from 2 to 5 years. While these funds have the potential to give better returns compared to liquid or short term debt funds, they can be much more volatile during changing interest rate scenario. Fixed Maturity Plans Fixed Maturity Plans (FMPs) invest in various types of debt instruments such as corporate bonds, debentures, government securities, commercial papers, call money, etc. The key point in the investment strategy followed by these plans is that investments are made in instruments whose maturity will coincide with a specific time period indicated in advance by the mutual fund. As a result, FMPs carry least interest rate risk. In other words, the objective is to lock-in the investments at a specified rate of return thereby immunizing the scheme against market fluctuations. * Why FMPs are more lucrative than Bank FDs? FMPs have maturities ranging from one month to two years or even more. Therefore, investors who are sure about the time periods for which they can keep the money invested, FMPs are an ideal option as they offer not only predictable returns but also are tax efficient than bank deposits. The key, however, is to select an appropriate option i.e. dividend or growth. For an investor who invests in a short term FMP i.e. say 3 months or 6 months and is in a higher tax bracket, dividend option would be ideal. On the other hand, for an investor who invests in one year FMP, growth option would be better. Arbitrage Funds Arbitrage funds are essentially equity funds that aim to provide capital appreciation and income through arbitrage opportunities that exist between the spot market and derivative market. It is important for investors to know that though these are termed as equity funds, they are suitable for those investors who are looking to get better and tax efficient returns compared to debt funds. That’s possible because these are market neutral funds and enjoy the tax benefits of an equity fund i.e. tax free dividends and zero tax on long term capital gains. Being an equity funds for the tax purposes, even the fund is not required to pay any dividend distribution tax. However, for investors in arbitrage funds that invest less than 65% in equities, the applicable tax rules will be that of debt funds. On the negative side, these funds at times might struggle to find enough arbitrage opportunities in the market.

Five Reasons to invest in Debt Funds

Though debt funds have got their own advantages, they are mostly ignored by common investors. Debt funds have got a unique place in your portfolio. Here are five simple situations, in which debt funds can be used by prudent investors.

 

https://www.holisticinvestment.in/debt-fund

 

Regards

Ramalingam K, MBA, CFP,

Director and Chief Financial Planner,

Holistic Investment Planners

“Best Performing Financial Advisor Award” Winners from CNBC TV18

www.holisticinvestment.in

(Follow us on)

https://www.facebook.com/holisticinvestmentplanners