What is the difference between liquid funds and ultra short term funds? Can you share the difference between these schemes in terms of liquidity, volatility and taxation? I am going to get married next month and I want to create an emergency fund for our future needs.
- Vipul
A contingency fund ensures that an unforeseen event does not upset your financial plans in a big way. The fund should be large enough to cover the living expense of three to six months. It should also kept in a liquid investment avenue like bank deposits and liquid funds. One can keep 50 per cent of the corpus in a bank deposit that can be broken easily. The other half can be kept in a liquid fund where you would get the money on a day's notice.
Liquid funds invest in highly liquid money market instruments and provide easy liquidity. They are ideal to park cash for a short period of, say, a few days to a few months. They invest in instruments with an average maturity of up to 91-days and they are less volatile than other funds. Ultra short-term funds invest in very short term debt securities with a small portion in longer term debt securities. Most ultra short term funds invest in securities with a residual maturity of less than a year. They are suitable to park money for a few months to a year. Ultra short term funds are suitable for investors who are willing to take a marginally higher risk to earn a little extra returns.
Both these funds are taxed similarly. If investments in them are sold before three years, you have to pay a short-term capital gains at the Income Tax slab applicable to you. If investments are sold after three years, you should pay a long-term capital gains tax at 20 per cent with indexation benefit.
This article was originally published on February 10, 2016.
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