Liquid fund risk: An assessment of the risk associated with liquid fund investments

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Imagine having the ability to access your investment within just 91 days while being able to earn more than you would with a fixed deposit or savings account. Liquid funds offer such an opportunity to boost your short-term goals and optimise your financial situation.

By investing in high-quality debt and money market instruments such as treasury bills, government securities, commercial paper, and certificates of deposits, liquid funds offer the potential for stable returns within a short period. They can be used to maintain an emergency fund, park your large corpus temporarily, or for other short-term goals.

But to maximise the potential of liquid funds in your portfolio, it’s important to understand the associated risks and their compatibility with your individual financial situation. On that note, here are some useful insights on what risks you should consider before committing to liquid funds as part of your investment portfolio.

  1. Interest rate risk

Although short maturities make liquid fund investments less susceptible to interest rate risk, they are not entirely risk-free. If the rates increase or decrease significantly, the total value of your investment can still be impacted. As such, you should keep track of interest rate changes when you invest in liquid funds so that you can plan accordingly and minimise potential losses or maximise potential gains.

  1. Credit risk

This risk refers to the potential for losses due to issuers defaulting on their debt obligations or failing to repay their loans on time. To reduce this kind of risk, it is crucial to conduct research on debt issuers before investing.

Invest in high-quality instruments with strong credit ratings from reputable rating agencies. For example, when investing in bonds, a AAA rating from a reputable rating agency indicates high quality with minimal chance of default.

Additionally, it is advisable to diversify your mutual fund portfolio among different issuers to avoid being overly exposed to one particular issuer.

  1. Inflation risk

As liquid funds invest mainly in short-term investments, their returns are usually lower than stocks and other debt funds. As a result, inflation may outpace the rate of liquid fund returns anticipated by you. This means that if inflation rises significantly during the period when your money is invested in a liquid fund, you may lose purchasing power due to rising prices – even though your investment has earned positive returns during the same period.

By spreading the risk across multiple types of investments, such as stocks, bonds, or cash equivalents, you can limit the impact of inflation on your returns.

To wrap up

While there are certain risks associated with liquid fund investments, these can be managed through careful research, monitoring of economic conditions, and market sentiment. Furthermore, by investing in quality securities and diversifying across different asset classes, you can also minimise your risk exposure while still enjoying the benefits of liquid funds.

For more personalised advice, you can seek the help of a financial advisor. With their expert guidance, you can develop an effective mutual fund investment strategy to balance risk-returns ratio and work on achieving goals within your timeframe.