With the changes in the tax structure proposed in Union Budget 2014, I would like to ask you questions on Liquid fund investments.
- What one should do with the liquid fund investment (when holding time is ~6 months) and why?
- After the recent CPI & WPI numbers, I believe interest rates have peaked out and are likely to start reducing in next few quarters. Will this have any impact on liquid funds?
- Abhay Nafde
The budget has made the capital gains on liquid funds taxable at your marginal rate of income tax, if you hold them for any period upto 3 years. Earlier, holdings beyond one year enjoyed a concessional rate of long term capital gains tax at 10 per cent. Now only holdings for 3 years an above will be defined as long term capital gains and that too they will be taxed at 20 per cent with indexation benefits. But we do not see why this should affect your decision to buy a liquid fund. The objective of a liquid fund is to provide reasonable returns while maintaining high level of liquidity through investment in a mix of money market instruments and debt securities. Liquid funds, even after the tax changes will remain a good parking ground for short term money for those who would otherwise keep their money in savings account. These funds do not invest any part of assets in securities with a residual maturity of more than 91 days. The short term nature makes them relatively less sensitive to interest rate fluctuations compared to other debt funds. The short term rates in the debt market are a function of the prevailing liquidity conditions in the market as well as of interest rates. If interest rates fall over time, the returns on liquid funds may moderate. But if liquidity conditions remain tight, you can still expect a reasonable return from them.
Currently, liquid funds are earning a 8 per cent return, but this can change based on market conditions. While you can expect liquid funds to generate better returns than savings accounts with banks, if you are keen to earn a good return on your debt portfolio for the long term you should prefer income or short term income funds.
This article was originally published on August 21, 2014.
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