Ashutosh Gupta explains why you shouldn't think about returns when investing in liquid funds
Do liquid funds generally beat or keep up with inflation? I'm wondering where to park my emergency fund and don't quite like the idea of it being in a bank as, in the long-term, I'll lose money.
- Vishnu Anil Kumar
Liquid funds are not designed to generate inflation-beating returns, and they are certainly not beating inflation in the current environment of exceptionally low interest rates. Having said that, over a period, one can reasonably expect liquid funds to generate slightly better returns than what a bank account would fetch. They are a suitable alternative to park your emergency corpus.
It's important that while picking a liquid fund or setting your expectations from that fund, you are not driven by the thought of returns. Returns are always secondary criteria when investing in a liquid fund. You should go with a fund that is low on expenses and high on risk-mitigating techniques such as a high degree of diversification and maintains a high-quality portfolio in terms of credit quality. So, as long as a fund delivers marginally better returns than a savings bank account, that should be acceptable. Because when you look at the liquid fund category, it is possible to find funds that deliver outlying returns, but that often also comes with risks of an outlying magnitude.
So don't get carried away by the returns side of the equation. Focus more on the expenses and the risk side of the equation and keep returns as secondary criteria.