How to choose the best Liquid Mutual Fund for your portfolio?
Many investors use liquid funds as an option to park excess money for a short duration and to gain a decent yield. But selecting an appropriately liquid fund is also important to generate more returns. Investors find it a bit difficult to choose liquid funds as they are unable to understand what aspects to focus and what to ignore.
To simplify this lets have a look at the liquid funds and the key aspects to look for while selecting them.
Meaning of Liquid Funds
Liquid funds are the funds which invest in short-term money market instruments and other debt securities. These funds enjoy high liquidity due to the shorter span of maturity of the underlying securities. These schemes are not affected by the market movements so are considered to be the least volatile schemes. The investment in these schemes is less risky as compared to pure equity schemes. Moreover, these funds do not have any lock-in period which gives the investor a freedom to enter and exit the scheme whenever he wants, as well as there are very few chances of losing capital in these schemes as the asset allocation is primarily in the government securities.
Points to focus while choosing Liquid Funds
Interest rate risk /Credit Risk: The schemes under liquid fund category have lesser risk even though its important to review the portfolio of the scheme before investing into it. The portfolio concentration gives a proper idea of the credit risk factors associated with the investment the changes in the interest rate can hurt the funds returns as the investment of these funds is majorly in the securities which have a lower maturity period. So while selecting the liquid fund scheme one should look for the credit risk involved in the investment.
Credit Ratings- Another important aspect to look while investing into the liquid funds is credit ratings of the instruments. Credit rating agencies assign a rating to the debt instruments which authenticate the credibility of the instruments. So instruments with the higher ratings are usually considered as the safer choices.
Portfolio composition- Investor should study various instruments in which the investments have been made by the fund managers. This will help investors to understand the capacity of the scheme to generate expected returns over a shorter span. These funds have nearly zero mark-to-market component so it is good to stick to the quality portfolios. Also, it is advised that investors should look into the break up of securities to know the exact liquidity of the investment.
Fund house and costs- A fund house with long-term track record should be preferred by investors as it gives an idea of the fund house's ability in tackling down cycles. Also the total expense ratio is an another factor which impacts the returns of the investment. So a lower expense ratio can be preferred.