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Risks in liquid funds

Liquid funds are debt funds that invest in very short-term instruments such as call money, treasury bills, certificates of deposit, commercial paper, etc. that hold very little risk

What is the risk associated with investing in liquid funds? Should they be favoured over other debt funds?
- Sachin Santuka

Liquid funds are debt funds that invest in very short-term instruments such as call money, treasury bills, certificates of deposit, commercial paper, etc. that hold very little risk. Though these funds can invest in instruments with a maturity of up to 91-days, the average maturity of investments is mostly much lower than that. They are the least risky and least volatile among debt funds. This is mainly because these funds mostly invest in highly-rated instruments. Also, their NAV is not very volatile because the change in NAV is mostly because of the interest accruals. Since these funds invest in very short-term instruments, they are not actively traded in the money market.

However, you should not base your investment decisions only on the basis of risk and volatility. Liquid funds are ideal for parking money for a few days to weeks. However, if you have a longer investment horizon, you should consider investing in other debt funds that match your investment horizon. For example, if you are going to keep the money for a year or so, you can consider investing in ultra short term schemes. Or you can consider investing in dynamic debt funds if you are investing the money for three to five years. Sure, these funds can be a little volatile in the short-term, but you may come out without unscathed since you have a longer investment horizon.

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