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You must know before you invest in the best liquid mutual funds

Read this article if you are in a hurry to invest in the best mutual funds… Bond yields were slowly declining in early 2013. The Reserve Bank of India (RBI) has stumbled from rate to rate.

In a series of rate cuts, the central bank lowered the benchmark repo rate from 8 per cent in early January 2013 to 75 basis points in May 2013 to 7.25 per cent. Bond yield dropped and debt investors are rejoicing.

Investors are confident that the central bank had expected more rate cuts.

US Federal Reserve President Ben Bernanke said the central bank plans to roll back its bond purchase program by the end of June 2013 if the economic recovery is on track. It stopped the sale of currencies, shares and bonds in the emerging market.

FIIs were selling Indian debt stock by the truckload, resulting in increased yields and a fall in the rupee.

RBI decided to step up on 16 July 2013 to eliminate excess liquidity of the system. The RBI raised the marginal standing facility (MSF) rate from 200 bps to 8.25% to 10.25%, making it more expensive for banks to borrow and thereby tighten liquidity. The level of banks rose to 10.25%.

The measure prompted banks and corporations to invest in debt funds, particularly best liquid funds, ultra-short-term funds and short-term funds in mutual fund houses. Such excessive redemptions by these companies led to a very high supply of these securities and hence, a fall in their values.

While unusual, shareholders in liquid funds held negative returns.

Liquid funds are low risk but not risk-free: The negative returns on liquid funds and other debt investments came as a shock to debt mutual fund investors.

Fund houses and distributors have been strongly supportive of debt funds as an alternative to fixed deposits and other fixed-income products. Unfortunately, the threat is not exposed. Investors had to learn the hard way.

Liquid funds are a great way to manage money in the short term. But before you add the best liquid funds to your portfolio, it is essential to know what they are, how they work, and what risks you can afford.

How do liquid funds work?

Liquid funds invest your money in the same way that you deposit in a bank. Such funds are invested in short-term debt instruments maturing in less than 13 months. But on average, they have a maturity of fewer than 90 days. By keeping within a short time frame, these funds try to reduce the risk.

Although liquid funds are the lowest form of investment uncertainty, they are not entirely risk-free.

Risks of Liquid Mutual Funds: 

Liquid funds, like all mutual funds, invest risk, including potentially significant losses. Investors should be aware of the risk and loss potential of liquid fund investments.

Investing in liquid mutual funds is generally less risky – and less rewarding – than investing in mutual stock funds. Similarly, a bank deposit at a fixed interest rate offers lower risk stock mutual funds and lower returns than mutual fund funds.

Yields fluctuate on the debt market and are not guaranteed. Since investments are market-related, the value of the investment may decrease or increase.

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